The United States Tax Court recently released its opinion in the Sumner Redstone case. The case is notable not just because Redstone is a media magnate, but also because Redstone, like myself, is a former government tax attorney. The case involved the question of whether certain transfers of stock were a taxable gift to his children. The IRS pursued the civil fraud penalty, which the Court did not sustain. However, the Tax Court has held that the transfer was taxable. The full text of the opinion is below and can be found at the Tax Court site here.
T.C. Memo. 2015-237
UNITED STATES TAX COURT
SUMNER REDSTONE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8097-13. Filed December 9, 2015.
David R. Andelman, Juliette M. Galicia, Lawrence Michael Hill, and
Richard A. Nessler, for petitioner.
Carina J. Campobasso and Janet F. Appel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LAUBER, Judge: The Internal Revenue Service (IRS or respondent) determined
against petitioner a gift tax deficiency of $737,625 for the calendar quarter
ending September 30, 1972. Respondent also determined an addition to tax of
$368,813 under section 6653(b) for fraud and (alternatively) an addition to tax of
SERVED Dec 09 2015
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[*2] $36,881 under section 6653(a) for negligence and an addition to tax of
$184,406 under section 6651(a)(1) for failure to file a timely gift tax return.¹ The
focus of the parties’ dispute is whether petitioner’s 1972 transfer of stock to his
children was a “gift” for Federal gift tax purposes or was (as petitioner contends) a
transfer for an “adequate and full consideration in money or money’s worth.” See
sec. 2512(b). We find that this transfer was a taxable gift and determine its value
on the transfer date. We conclude that petitioner is not liable for any additions to
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations of
facts and the attached exhibits are incorporated by this reference. When he petitioned
this Court, Sumner Redstone (Sumner or petitioner) resided in California.
Family and Business Background
Michael “Mickey” Redstone was born on April 11, 1902. He married Belle
Redstone, and the couple had two children, Sumner and Edward. Sumner graduated
from Harvard College in 1944 and Harvard Law School in 1947. He practiced
¹All statutory references are to the Internal Revenue Code (Code) in effect
for the tax period in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure. We round all dollar amounts to the nearest dollar. During
1972, the tax period in issue, what are now “penalties” for fraud and negligence
were denominated “additions to tax.”
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[*3] law for several years, including a stint in the Tax Division of the U.S. Department
of Justice, before starting work in 1954 for the family business. Sumner
married Phyllis, and they had two children, Brent and Shari. Edward attended
college and business school before joining the family business in 1952. He
married Leila, and they likewise had two children, Michael and Ruth Ann.2
Mickey entered the drive-in movie theater business in 1936. Between 1936
and 1954, Mickey bought real estate throughout the Northeast and built numerous
drive-in theaters. He incorporated Northeast Theatre Corporation (Northeast) in
1954, and it became the management company for the Redstone family business.
For each drive-in theater, Mickey typically incorporated three separate entities:
one to own the real estate, one to operate the theater, and one to manage refreshments.
Mickey, Edward, and Sumner eventually came to own various percentages
of these various corporations, with Mickey’s aggregate share being the largest.
As the family business grew, this complex corporate structure made it cumbersome
to obtain financing. To solve this problem and to consolidate the interests
of Mickey, Edward, and Sumner in a single entity, National Amusements, Inc.
2Edward died in 2011, and his estate is the petitioner in Estate of Redstone
- Commissioner, 145 T.C. __ (Oct. 26, 2015). While that case and the instant
case share a common factual background, they present different issues and the
resolution of these issues depends to some degree on different evidence.
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[*4] (NAI) was incorporated as a holding company on August 28, 1959. Its
articles of incorporation named Mickey, Edward, and Sumner as the original
directors; Mickey was elected president, Sumner vice president, and Edward
secretary-treasurer. At the time of trial, NAI was a closely held corporation headquartered
in Norwood, Massachusetts.
Upon NAI’s incorporation, Mickey, Edward, and Sumner each contributed
to it their stock in the pre-existing movie companies. The book value of the stock
that each contributed was $30,328, $17,845, and $18,445, respectively. Mickey
also contributed $3,000 in cash. According to the minutes of the first meeting of
directors dated September 1, 1959, a total of 300 shares of class A voting common
stock were to be issued: 100 shares each to Mickey, Edward, and Sumner. It was
Mickey’s decision to divide the shares evenly. Consistently with these decisions,
the stock certificates indicated that Mickey, Edward, and Sumner were each registered
owners of 100 unrestricted shares of NAI common stock. All of the physical
stock certificates were retained in NAI’s corporate office.
The decisions taken at NAI’s organizational meeting contained the seeds of
the problem that would blossom into the tax dispute now before us. Whereas
Mickey, Edward, and Sumner were each registered owners of 33.33% of NAI’s
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[*5] stock, the values of their contributions to NAI were disproportionate to their
shareholdings, as follows:
Item Mickey Sumner Edward Total
Cashcontributed $3,000 -0- -0- $3,000
Property contributed 30,328 $18,445 $17,845 66,618
Total 33,328 18,445 17,845 69,618
Percentage 47.88% 26.49% 25.63% 100%
The 1968 Redemption
As he approached age 70, Mickey developed a plan to retire gradually from
active involvement in NAI’s operations. To implement this plan, he decided to
transfer a portion of his common stock to his grandchildren and to exchange the
balance of his shares for preferred stock.
On May 6, 1968, Mickey as settlor executed an agreement of trust for the
benefit of his four grandchildren (Grandchildren’s Trust). The three trustees were
Belle, Edward, and Sumner. That same day, Mickey transferred 50 shares of NAI
common stock to the Grandchildren’s Trust. His accountants at J.K. Lasser &
Company (J.K. Lasser) prepared and filed on his behalf a timely Federal gift tax
return valuing these shares at $564,075, and Mickey paid the resulting gift tax due.
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[*6] Belle likewise filed a Federal gift tax return consenting to have Mickey’s gift
treated as having been made one-half by her.
Mickey then exchanged his remaining 50 shares of NAI common stock for
preferred stock. In December 1968 NAI’s charter was amended to provide for a
class of preferred stock, and in March 1969 Mickey’s 50 shares of common stock
were redeemed in exchange for 86,780 shares of NAI preferred stock. Thus, as of
March 31, 1969, NAI had outstanding 250 shares of voting common stock that
were owned by Sumner (100 shares), Edward (100 shares), and the Grandchildren’s
Trust (50 shares).
As time went on Edward became increasingly dissatisfied with his role at
NAI and with certain decisions that Mickey and Sumner had made. Also during
this period, one of Edward’s children was experiencing serious problems that were
a source of frustration and distraction to him. For a variety of reasons, he decided
in June 1971 to terminate his employment with NAI.
Upon leaving, Edward demanded but did not receive possession of the 100
shares of common stock registered in his name. To help secure possession of
these shares, Edward hired attorney James R. DeGiacomo. Edward took the position
that he was legally entitled to, and had an unrestricted right to sell, the shares
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[*7] registered in his name. He threatened to sell the shares to an outsider if NAI
did not redeem them at an appropriate price.
Edward’s threat to sell his shares to an outsider was anathema to Mickey
and Sumner because they wished to keep control of the Redstone businesses
within the family. Mickey refused to give Edward his stock certificates, contending
that NAI had a right of first refusal to repurchase the shares. Mickey and his
attorneys also developed an argument that a portion of Edward’s stock, though
registered in his name, had actually been held since NAI’s inception in an “oral
trust” for the benefit of Edward’s children. This argument built on the fact that
Mickey in 1959 had contributed 48% of NAI’s capital yet had received only
33.33% of its stock. In effect, Mickey contended that he had gratuitously
accorded Edward more stock than he was entitled to, and that, to effectuate
Mickey’s intent in 1959, the “extra” shares should be regarded as being held in
trust for Edward’s children. Mickey took the position that at least half of
Edward’s shares were covered by this alleged oral trust.
The parties negotiated for six months in search of a resolution. They explored,
without success, various options whereby Edward would remain in the
business as an employee or consultant. Edward offered to sell his 100 shares back
to NAI, and the parties explored various pricing scenarios under which this might
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[*8] occur. As the family patriarch, however, Mickey had most of the leverage,
and he insisted that Edward acknowledge the existence of an oral trust for the
benefit of Edward’s two children. Mickey’s insistence on an oral trust was a “line
in the sand” and a “deal breaker.”
Upon reaching an impasse, Edward authorized Mr. DeGiacomo to file in
Massachusetts Superior Court two lawsuits against Mickey, Sumner, and the Redstone
family companies: Redstone v. Nat’l Amusements, Inc., No. 94575 EQ (NAI
Action), and Redstone v. Northeast Theatre Com., No. 94576 EQ (Northeast
Action). The NAI Action, filed in December 1971, alleged that Edward owned 100
shares of voting common stock, that these shares were “unencumbered and
unrestricted as to their transferability,” and that the 100 shares should be delivered
immediately to Edward. Mickey answered that he had possession of all the stock
registered in Edward’s name and that a portion of the shares so registered were
“held in trust for the benefit of * * * [Edward’s] children.”
This litigation became quite adversarial, and its public nature was extremely
distressing to the Redstone family, especially Mickey’s wife, Belle. She implored
Edward to reach some accommodation with his father. In the course of negotiations,
it became apparent to Mr. DeGiacomo that Edward had to separate com_
[*9] pletely from NAI and that Mickey would not be satisfied unless some of
Edward’s disputed shares were placed in trust for his children, Michael and Ruth
A settlement was ultimately reached along these lines. Notwithstanding that
100 shares of NAI voting common stock were registered in Edward’s name, the
parties agreed that Edward was the owner “free and clear of all trusts, restrictions
and encumbrances” of only 66 2/3 shares of such stock. They further agreed that
the remaining 33 1/3 shares of NAI stock registered in Edward’s name were then
held, and had always been held by Edward, “for the benefit of his children * * * in
trust and not as beneficial owner.” This settlement was a compromise of the parties’
respective positions. It reflected, on the one hand, Mickey’s desire to ensure
the financial security of Edward’s children and, on the other hand, Edward’s desire
to conclude the litigation by securing payment for at least some of his shares.
The settlement agreement dated June 30, 1972 (Settlement Agreement) provided
that NAI would repurchase the 66 2/3 shares of stock that Edward was
deemed to own. The parties agreed that Edward’s 66 2/3 shares were to be valued
at $5 million and that a redemption agreement would be executed simultaneously.
Edward and NAI executed the Redemption Agreement, which provided that the $5
million purchase price would be paid as 44 quarterly installments of $125,000
– 10 –
[*10] (including principal and interest), plus a final payment of all principal and
interest then remaining due. NAI executed an installment note that bore interest at
the “floating prime rate” charged by the Boston bank from which NAI had obtained
most of its financing. In exchange for this stream of payments, Edward executed
an assignment transferring 66 2/3 shares of voting common stock to NAI.
The Settlement Agreement required Edward to execute irrevocable declarations
of trust, likewise dated June 30, 1972, for the benefit of his children. These
trusts were styled the Ruth Ann Redstone Trust (Ruth Ann Trust) and the Michael
David Redstone Trust (Michael Trust). Sumner was named the sole trustee of each
trust. Edward executed two assignments, each transferring 16 2/3 shares of NAI
stock to Sumner as trustee of the respective trusts.
Finally, the Settlement Agreement required the parties to execute various
releases. All parties executed mutual releases respecting claims concerning Edward’s
ownership interests in NAI and Northeast. Edward resigned from all positions
he had held in the Redstone family businesses and resigned as trustee (or relinquished
the right to serve as successor trustee) of all Redstone family trusts. The
Settlement Agreement also resolved certain disputes in the Northeast Action that
are not relevant here.
– 11 –
[*11] On July 19, 1972, the parties filed with the Massachusetts Superior Court a
Stipulation in the NAI Action setting forth the terms of this settlement. That same
day, the Massachusetts Superior Court issued a Final Decree incorporating the
terms of the Settlement Agreement as set forth in the Stipulation.
Sumner’s Transfer of Stock to Trusts for His Children
On July 21, 1972, three weeks after the Settlement Agreement was signed,
Sumner executed irrevocable declarations of trust for the benefit of his two children.
These trusts were styled the Brent Dale Redstone Trust (Brent Trust) and the
Shari Ellin Redstone Trust (Shari Trust). Sumner was named the sole trustee of
each trust. That same day, 16 2/3 of the NAI shares originally registered in Sumner’s
name were re-issued to the Brent Trust; 16 2/3 shares were re-issued to the
Shari Trust; and the remaining 66 2/3 shares were re-issued to Sumner. Neither
Sumner nor his wife filed a gift tax return for the calendar quarter ending September
Sumner’s transfers of NAI stock to the Brent and Shari Trusts were voluntary.
Each transfer was motivated by donative intent toward the natural objects of
Sumner’s affection. By creating these trusts and transferring 33 1/3 shares of NAI
stock to them, Sumner made a gesture of goodwill toward his father, who desired to
ensure the financial security of his four grandchildren on equal terms. However,
– 12 –
[*12] Sumner was not required to take these actions by the Settlement Agreement
that resolved Edward’s lawsuits. The only obligation that the Settlement
Agreement imposed on Sumner was the requirement that he execute certain
releases in consideration of mutual releases executed by the other contracting
The Brent and Shari Trusts, like the Ruth Ann and Michael Trusts, recite that
the stock transferred to them had been held “under an oral trust” since 1959. Petitioner
presented no evidence that any “oral trust” actually existed whereby Edward
or Sumner held in trust for his children a portion of the NAI shares initially registered
in his name. Rather, the concept of an “oral trust” developed later and was
agreed upon as a mechanism for settling Edward’s litigation and implementing
Mickey’s desire to ensure the financial security of Edward’s children.
On March 8, 1984, NAI redeemed the 83 1/3 shares held collectively by the
Grandchildren’s Trust (50 shares), the Ruth Ann Trust (16 2/3 shares), and the
Michael Trust (16 2/3 shares). The aggregate redemption price was $21,428,571,
or approximately $257,143 per share. Following this redemption, NAI had
outstanding only 100 shares of voting common stock. These shares were owned by
– 13 –
[*13] Sumner individually (66 2/3 shares) and by the two Trusts for his children
(33 1/3 shares), of which he was the sole trustee.
The O’Connor Litigation
Litigation commenced in 2006 sheds further light on the events involved in
this case. See O’Connor v. Redstone, 896 N.E.2d 595 (Mass. 2008). Michael
Redstone and the trustees of certain Redstone family trusts sued Sumner, Edward,
and NAI, advancing two major contentions. First, they alleged that Sumner in
1984 had improperly caused NAI to redeem, for less than fair market value, the
shares held by the Ruth Ann Trust, the Michael Trust, and the Grandchildren’s
Trust. The Massachusetts Supreme Court eventually held that this claim was time
barred. See id. at 616. Second, the plaintiffs alleged that, in 1972, additional stock
should have been transferred to the various Trusts based on the purported existence
of a prior “oral trust.” The “oral trust” issue was the subject of extensive deposition
and trial testimony.3 The trial court concluded that the plaintiffs had failed to
prove that an oral trust was ever created. O’Connor v. Redstone, No. 2006-4606
(Mass. Sup. Ct. Nov. 25, 2009).
3The trial transcript of the O’Connor litigation and the transcripts of certain
depositions are included among the exhibits to the parties’ stipulation of facts in
the instant case.
– 14 –
[*14] In deposition and at trial of the O’Connor case, Sumner testified that he had
transferred the 33 1/3 shares of NAI stock to the Brent and Shari Trusts voluntarily.
At his deposition, he explained that he “voluntarily went through the same procedure”
as his brother and “gave * * * [his] own children” the stock. While it was
Mickey’s position “that at least 50 percent” of Edward’s shares were held for
Edward’s children, Sumner testified that Mickey had never expressed the same reservation
regarding Sumner’s own shares. He continued: “I voluntarily set up an
arrangement–call it what you will–where my own children would get a third of the
stock. * * * I wanted to do the same thing that my brother did, only he did it as a
result of litigation. I did it voluntarily.”
At trial in the O’Connor case Sumner maintained the same position: “Nobody
sued me. I gave my kids a third of the stock voluntarily, not as the result of a
lawsuit. In [s]o doing, I did what I wanted and appeased my father too.” He testifled
that “[t]here was a big difference between Eddie’s position and mine” because
Edward “was resisting doing what my father wanted,” whereas Sumner was simply
trying to maintain good family relations. He later testified to the same effect:
“Eddie was sued. I was not. And Eddie had to find a justification for what he was
doing in transferring. I wasn’t sued. I just made an outright gift.”
– 15 –
[*15] Contemporaneous Tax Advice
During the 1960s Samuel Rosen was a partner at J.K. Lasser, and Peter Isenberg
was a certified public accountant there. (J.K. Lasser subsequently merged
with Touche Ross & Co., now Deloitte.) After the 1972 transaction, Messrs. Rosen
and Isenberg formed their own firm (Rosen PC) through which Mr. Rosen served
as the Redstone family accountant. He worked for Sumner and NAI before the
1972 transactions and continued to do so for many years afterwards. Mr. Isenberg
described Mr. Rosen, who was deceased at the time of trial, as a knowledgeable
and careful professional who always endeavored to get the right answer.
Sumner sought and received advice from Mr. Rosen about the tax consequences
of his transfer of stock to the Brent and Shari Trusts. Mr. Isenberg
credibly testified: (1) that Mr. Rosen had obtained advice from J.K. Lasser’s
national office about this transaction; (2) that this advice was memorialized in a
letter or memorandum which concluded that Sumner was not required to file a gift
tax return because he had made no taxable gift; and (3) that Mr. Rosen, who was
thoroughly familiar with the 1971 litigation and its aftermath, expressed his agreement
with J.K. Lasser’s conclusion.4 Mr. Isenberg personally handled petitioner’s
4Mr. Isenberg was unable to locate a copy of the advice document from J.K.
Lasser’s national office. The Court found this unsurprising because that document
– 16 –
[*16] income and gift tax filings. He credibly testified that if J.K. Lasser had
believed a gift tax return was due for the quarter ending September 30, 1972, a
return would have been filed.
The tax consequences of Sumner’s 1972 transfer were likewise addressed
during the O’Connor litigation. Mr. DeGiacomo testified in deposition that J.K.
Lasser provided a tax opinion for the transaction. Sumner testified that Mr. Rosen
“would have made the determination” whether a gift tax return was required to be
filed. “If there were a gift tax due and gift tax return, it would have been filed. If
there was a gift tax * * * due, it would have been paid.” Consistently with that
previous testimony, Sumner testified in the instant case that he had relied on his accountants
and lawyers to determine whether gift tax had to be paid in 1972 and
“[t]hey apparently concluded that there was no tax due.”
Sumner has filed 34 Federal gift tax returns during the course of his life. He
filed the first such return in 1970; the next two in 1980; and 32 additional returns
for various periods between 1982 and 2012, all reporting taxable gifts. On the
basis of the advice he received from Mr. Rosen and J.K. Lasser, however, Sumner
did not file a Federal gift tax return for the quarter ending September 30, 1972.
would have been drafted 43 years ago. Mr. Isenberg credibly testified that he recalled
seeing this document contemporaneously with the events in question.
– 17 –
[*17] IRS Scrutiny of Petitioner
During 1974, in the wake of the Watergate investigation, the IRS initiated
what was called the Political Campaign Contribution Compliance Project (Compliance
Project). A Senate Select Committee on Presidential Campaign Activities had
expressed concern that some donors might be evading the law by making donations,
in amounts smaller than the $3,000 annual gift tax exclusion, to multiple
campaign committees that were nominally separate but in fact supported the same
candidate. Congress asked the IRS to investigate these concerns. The Compliance
Project sought to determine whether transfers of this type involved taxable “gifts”
for Federal gift tax purposes.
The Senate Select Committee provided the IRS with lists of contributions
that were to be reviewed. Sumner’s name appeared on a list of 12 to 14 contributors
in the North Atlantic region who had made political contributions during
1970-1972; this list was assigned to IRS Revenue Agent Corbett for review. Agent
Corbett testified that the scope of his review was limited to the political campaign
contributions made by these individuals. He was unsure whether he technically
had authority, under the scope of the Compliance Project, to investigate other gift
tax issues that might have come to his attention.
– 18 –
[*18] In April 1975 Agent Corbett mailed Sumner a letter captioned “Possible
1971 and 1972 Gift Tax Liability.” The letter asked Sumner to identify all transfers
he had made to political committees during 1970-1972 and to provide copies
of canceled checks documenting any such transfers. Sumner promptly provided the
requested documentation, including schedules of his transfers to political committees
during 1970-1972, copies of all relevant cancelled checks, and copies of
promissory notes he had received for two loans executed in 1971. On the basis of
this information the IRS concluded that “there was no necessity to solicit a gift tax
return for 1972.”
In 2010, apparently as a result of the O’Connor litigation, Sumner’s 1972
transfer of stock to the Brent and Shari Trusts came to the IRS’ attention. It accordingly
commenced, in May 2011, a gift tax examination covering petitioner’s
1972 calendar year. IRS Revenue Agent Cha was assigned to conduct this examination.
The focus of his examination was petitioner’s potential gift tax liability
related to the 1972 stock transfer. Agent Cha was not aware, when conducting this
examination, that the IRS had performed an earlier review of Sumner’s 1972 political
Agent Cha’s examination lasted more than a year. On several occasions, he
requested documents that the IRS did not possess, and Sumner through his attor-
[*19] neys complied with each of these document requests. Sumner did not
complain, at any time during the audit, of a potential “second examination” in
violation of section 7605(b). He first raised the possibility of a “second
examination” in early 2014, nearly a year after the IRS had issued the notice of
deficiency. That notice was issued on January 11, 2013, and Sumner timely
petitioned this Court on April 10, 2013.
Expert Valuation Testimony
At trial respondent offered, and the Court recognized, Steven C. Hastings as
an expert in valuing closely held companies and stock interests in closely held
companies. Mr. Hastings relied principally on a “mergers and acquisitions” approach.
Employing this method, he valued the 33 1/3 shares of NAI stock that
Sumner transferred on July 21, 1972, principally by reference to the price at which
NAI had redeemed Edward’s 66 2/3 shares three weeks previously.
In Mr. Hastings’ opinion, the $5 million redemption price that NAI agreed to
pay Edward was negotiated at arm’s length, was essentially contemporaneous with
Sumner’s transfer, and yielded a value of $75,000 per NAI common share. Mr.
Hastings opined that NAI’s redemption of Edward’s shares “was a private transaction
for a minority interest” and that the redemption price thus established the
per-share value of NAI’s common stock “on a minority, non-marketable interest
– 20 –
[*20] basis.” Mr. Hastings accordingly concluded that the 33 1/3 shares that
Sumner transferred to his children’s Trusts in July 1972 were worth $2.5 million
(33 1/3 x $75,000).
Mr. Hastings also valued the transferred shares using the “direct capitalization”
and “guideline public company” methods. In performing these valuations,
Mr. Hastings concluded that a discount for lack of marketability was necessary; he
determined the appropriate discount to be 34%. Applying this discount, he determined
values for the 33 1/3 shares of $2,433,608 and $2,997,054, respectively.
Petitioner offered, and the Court recognized, Gordon Klein as an expert in
the field of business valuations. He determined the value of the transferred shares
using the so-called engrafting method. As his starting point for valuing the NAI
shares that Sumner transferred in July 1972, Mr. Klein used the per-share price,
$257,143, that NAI paid to redeem the Trusts’ shares in March 1984. He computed
ratios between the 1984 redemption price and (1) NAI’s average net income for
1981-1983 and (2) the book value of NAI’s common shareholders’ equity in 1984.
He then “applied these same ratios to comparable NAI data existing at or about the
time” of Sumner’s transfer. On the basis of these ratios, Mr. Klein concluded that
the 33 1/3 shares that Sumner transferred to his children’s Trusts in July 1972 were
worth $735,981 (33 1/3 x $22,079).
– 21 –
- Threshold Issues
- Burden of Proof
The Commissioner’s determinations in a notice of deficiency are generally
presumed correct, and the taxpayer bears the burden of proving those determinations
erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Petitioner does not contend that the burden of proof shifts to respondent under
section 7491(a) as to any issue of fact.
- Period of Limitations
Section 6501(c)(3) provides that, “[i]n the case of failure to file a return, the
tax may be assessed * * * at any time.” Sumner did not file a Federal gift tax return
reporting the 1972 transfer of stock to the children’s Trusts. The notice of deficiency,
though issued 41 years after the transfer, was thus timely. See Estate of
Brown v. Commissioner, T.C. Memo. 2013-50, at *8-*9. See generally Estate of
Sanders v. Commissioner, T.C. Memo. 2014-100, at *5.
Petitioner moved before trial for judgment on the pleadings. Admitting that
the period of limitations on assessment was “technically still open,” he contended
that respondent was barred by laches from determining in 2013 a gift tax deficiency
for the third quarter of 1972. Petitioner noted that he is “now 90 years old; material
– 22 –
[*22] witnesses have been dead for decades; documents have long since been
discarded or have disintegrated; memories have unquestionably eroded.” Under
these circumstances, petitioner described this case as involving “an unprecedented
abuse * * * of the rule that no statute of limitations applies.”
We denied this motion by order dated December 5, 2013, concluding as
It is well settled that the United States is not subject to the
defense of laches in enforcing its rights. See United States v. Summerlin,
310 U.S. 414, 416 (1940); Guaranty Trust Co. v. United
States, 304 U.S. 126 (1938); United States v. Menatos, 925 F.2d 333,
335 (9th Cir. 1991); Wright v. Commissioner, T.C. Memo. 2005-5, 89
T.C.M. (CCH) 662, 666. The inapplicability of the laches doctrine is
especially clear where (as here) the Government seeks to enforce tax
claims that are governed by an express statute of limitations. In such
cases, the “timeliness of Government claims is governed by the statute
of limitations enacted by Congress.” Fein v. United States, 22
F.3d 631, 634 (5th Cir. 1994). Accord Kohler v. Commissioner, T.C.
Memo. 2008-127, 95 T.C.M. (CCH) 1494, 1496-97; Wright v. Commissioner,
89 T.C.M. at 666.
A party asserting laches must establish certain facts. If this equitable defense
were available to petitioner, he would need to demonstrate (for example) that the
IRS was aware of the 1972 gifts but sat on its rights and that petitioner suffered
“undue prejudice” as a result. See, e.g., Fridovich v. Commissioner, T.C. Memo.
2001-32, 81 T.C.M. (CCH) 1143, 1146. Petitioner made no effort to establish such
facts at trial. Quite the contrary: the evidence indicated that the IRS did not be-
[*23] come aware of the 1972 transfers until 2010, after the O’Connor litigation
had ended, and respondent commenced his gift tax examination reasonably
promptly thereafter. In any event, petitioner did not advance arguments based on
laches or other equitable defenses in his pretrial memorandum or in his post-trial
briefs. See Mendes v. Commissioner, 121 T.C. 308, 312-313 (2003) (holding that
arguments not addressed in post-trial brief may be considered abandoned).
- Second Examination
Section 7605(b) provides that a taxpayer shall not be subjected to “unnecessary
examination or investigations, and only one inspection of a taxpayer’s books
of account shall be made for each taxable year unless the taxpayer requests otherwise
or unless the Secretary, after investigation, notifies the taxpayer in writing that
an additional inspection is necessary.” Congress enacted section 7605(b) to protect
taxpayers from harassment by “low-echelon revenue agents * * * by requiring such
agents to clear any repetitive examination with a superior.” United States v.
Powell, 379 U.S. 48, 55-56 (1964). “There is no intimation in the legislative history
[of section 7605(b)] that Congress intended the courts to oversee the Commissioner’s
determinations to investigate.”M The Court of Appeals for the Ninth
Circuit, to which an appeal in this case would lie absent stipulation to the contrary,
has accordingly “issued strong admonitions against an expansive reading of section
– 24 –
[*24] 7605(b).” Curtis v. Commissioner, 84 T.C. 1349, 1352 (1985) (citing De-
Masters v. Arend, 313 F.2d 79, 87 (9th Cir. 1963)).
Petitioner contends that the “deficiency should be set aside because respondent
* * * violated the ‘one examination’ rule of section 7605(b).” According to
petitioner, the review performed by Agent Corbett in 1975 pursuant to the Compliance
Project constituted an “inspection of * * * [petitioner’s] books of account,”
with the supposed result that the 2011-2013 gift tax examination was an impermissible
“second inspection” under section 7605(b). By way of remedy, petitioner
urges that we follow the analysis in Reineman v. United States, 301 F.2d 267 (7th
Cir. 1962), and set aside the gift tax deficiency in its entirety. We decline to do so.
At the outset, it is far from clear that Agent Corbett’s 1975 review constituted
an “inspection of [the] taxpayer’s books of account” within the meaning of
section 7605(b). “To inspect the ‘books of account’ would require, at a minimum,
that the respondent have access to and physically view a taxpayer’s books and records.”
Benjamin v. Commissioner, 66 T.C. 1084, 1098 (1976), afÕl, 592 F.2d
1259 (5th Cir. 1979). The IRS has long taken the position that narrow, limited contacts
between the IRS and taxpayers, such as “compliance checks” and “compliance
initiative projects,” do not constitute “examinations.” See Rev. Proc. 2005-32,
2005-1 C.B. 1206, 1207; Rev. Proc. 94-68, 1994-2 C.B. 803; Internal Revenue
– 25 –
[*25] Manual (IRM) pt. 220.127.116.11 (Jan. 25, 2011) (compliance checks); IRM pt.
18.104.22.168(3) (Feb. 25, 2010) (compliance initiative projects). Compliance initiative
projects involve “contact with specific taxpayers and collection of taxpayer data
within a group, using either internal or external data to identify potential areas of
noncompliance within the group, for the purpose of correcting the non-compliance.”
IRM pt. 22.214.171.124(3); see Michael Saltzman, IRS Practice and Procedure
para. 8.08, at 8-69 (July 13, 2013) (“Compliance checks are one specific type of
contact not considered by the Service to be an examination[.]”).
Agent Corbett contacted petitioner in 1975 as part of the Compliance Project,
which the IRS undertook at the request of the Senate Select Committee. The
purpose of this project was to determine the extent to which taxpayers were making
political contributions that did not comply with rules governing the annual gift tax
exclusion. Agent Corbett focused solely on this issue; he exchanged two letters
with petitioner and, after receiving copies of cancelled checks and two promissory
notes, was satisfied that petitioner was in compliance. Respondent contends that
Agent Corbett’s contact, given its limited nature, did not amount to an “examination”
of petitioner’s books of account. & Ellis v. Commissioner, T.C. Memo.
2007-207, 94 T.C.M. (CCH) 112, 116 (holding that IRS letter requesting specific,
limited information was not an “examination” even though the taxpayer furnished
– 26 –
[*26] copies of records in response), aff’d in part, rev’d in part on other grounds,
346 F. App’x 346 (10th Cir. 2009).
Even if the 2011-2013 examination constituted a “second inspection,” it is
far from clear that the remedy would be to expunge the gift tax deficiency that the
IRS determined during this examination. The purpose of section 7605(b) is to relieve
the taxpayer from unnecessary annoyance, not from payment of taxes legally
owed. The IRS is free to conduct a second examination so long as it “notifies the
taxpayer in writing that an additional inspection is necessary.” Sec. 7605(b). To
invalidate a notice of deficiency because the IRS neglected to send this explanatory
letter would “substantially overshoot the goal which the legislators sought to attain.”
United States v. Powell, 379 U.S. at 55. Accordingly, “[i]t has long been
established by this Court and others that failure of the Commissioner to comply
with the provisions of section 7605(b) * * * does not invalidate a deficiency determined
from information derived from such an examination.” Flynn v. Commissioner,
40 T.C. 770, 774 (1963). But see Reineman, 301 F.2d at 272. If the
taxpayer objects to an IRS contact as an impermissible “second examination,” he
may “refuse to permit the examination and, should the Service seek enforcement of
a summons, oppose the application for enforcement.” Saltzman, supra, para.
13.02, Westlaw (2013).
– 27 –
[*27] In any event, it is well settled that “if a taxpayer fails to object to a reexamination
or second inspection or voluntarily consents to one, he waives any rights
conferred by section 7605(b).” Id. As we noted soon after the predecessor of
section 7605(b) was enacted: “He might have refused to permit the investigation
without notice in writing [from the IRS], but not having done so the protection
afforded by the statute will be deemed to have been waived.” Estate of Barker v.
Commissioner, 13 B.T.A. 562, 566 (1928); accord, e.g., Moloney v. United States,
521 F.2d 491, 501 (6th Cir. 1975); United States v. O’Connor, 237 F.2d 466, 476-
477 (2d Cir. 1956); Credit Bureau of Erie, Inc. v. Commissioner, 54 T.C. 726, 729
(1970); Flynn v. Commissioner, 40 T.C. at 774; Philip Mangone Co. v. United
States, 54 F.2d 168, 172 (Ct. C1. 1931).
Agent Cha began his gift tax examination in 2011, and it lasted for more than
a year. He requested documents from petitioner on several occasions, and petitioner
through his lawyers complied with each such request. Petitioner did not complain
at any time during the audit of a potential “second examination” in violation
of section 7605(b). He first raised this issue in early 2014, nearly a year after the
IRS had mailed the notice of deficiency on which this case is based. Under these
circumstances, we conclude that petitioner consented to the 2011-2013 examination
and thus waived any rights that section 7605(b) might have afforded him.
– 28 –
[*28] We thus find it unnecessary to decide whether Agent Cha’s examination was
in fact a “second inspection” of petitioner’s books of account or what remedy
would be available to him if that question were answered in the affirmative.
- Application of Gift Tax
- Governing Legal Principles
During 1972 the gift tax was imposed for each calendar quarter “on the
transfer of property by gift” during that quarter. Sec. 2501(a)(1). “Where property
is transferred for less than an adequate and full consideration in money or money’s
worth, then the amount by which the value of the property exceeded the value of
the consideration shall be deemed a gift.” Sec. 2512(b). A necessary corollary of
this provision is that a transfer of property in exchange for “an adequate and full
consideration” does not constitute a “gift” for Federal gift tax purposes. See, e.g.,
Commissioner v. Wemyss, 324 U.S. 303 (1945). The regulations confirm that
“[t]he gift tax is not applicable to a transfer for a full and adequate consideration in
money or money’s worth, or to ordinary business transactions.” Sec. 25.2511-
1(g)(1), Gift Tax Regs.
The regulations define a “transfer of property made in the ordinary course of
business” as “a transaction which is bona fide, at arm’s length, and free from any
donative intent.” Sec. 25.2512-8, Gift Tax Regs.; see Weller v. Commissioner, 38
– 29 –
[*29] T.C. 790, 806 (1962). A transaction meeting this standard “will be
considered as made for an adequate and full consideration in money or money’s
worth.” Sec. 25.2512-8, Gift Tax Regs. A transfer of property within a family
group normally receives close scrutiny. See, e.g., Frazee v. Commissioner, 98 T.C.
554, 561 (1992). However, a transaction between family members may be treated
as one “in the ordinary course of business” if it constitutes an arm’s-length transfer
of property in settlement of a genuine dispute or otherwise meets the criteria set
forth above. See Stern v. United States, 436 F.2d 1327, 1330 (5th Cir. 1971);
Rosenthal v. Commissioner, 205 F.2d 505, 509 (2d Cir. 1953), rev’g 17 T.C. 1047
(1951); Estate of Friedman v. Commissioner, 40 T.C. 714 (1963); Beveridge v.
Commissioner, 10 T.C. 915, 917-918 (1948); Estate of Anderson v. Commissioner,
8 T.C. 706, 720 (1947).
- Sumner’s Transfer as a “Gift”
In Estate of Redstone v. Commissioner, 145 T.C. __, __ (slip op. at 31) (Oct.
26, 2015), we held that Edward’s June 1972 transfer of stock to his children pursuant
to the Settlement Agreement was not a gift but was a “transfer of property
made in the ordinary course of business.” Sec. 25.2512-8, Gift Tax Regs. We
found that a genuine dispute existed concerning Edward’s ownership of NAI stock
and that he was forced to relinquish his claim to ownership of 33 1/3 shares in
– 30 –
[*30] order to obtain from Mickey and Sumner an acknowledgment of his
ownership of the remaining 66 2/3 shares. We held that Edward’s transfer of the
disputed shares to trusts for his children, at Mickey’s insistence, was thus made for
a “full and adequate consideration in money or money’s worth.” Estate of
Redstone v. Commissioner, 145 T.C. at __ (slip op. at 31) (citing section 25.2512-
8, Gift Tax Regs.).
Three weeks after Edward’s litigation was settled, Sumner likewise transferred
33 1/3 NAI shares to trusts for his own children. In contending that this
transfer should also be exempt from gift tax, Sumner seeks to portray it as part of
the overall reconfiguration of stock ownership by which the parties brought Edward’s
litigation to a close. “But for the litigation with Edward and the settlement
reached by the parties,” Sumner submits that he would not have established trusts
for his children in July 1972. “By creating trusts he otherwise would not have
established at the time,” Sumner allegedly “facilitated the settlement of his
brother’s litigation,” “appeased his father,” and “poised himself to become NAI’s
majority shareholder.” He accordingly contends that his transfer, like Edward’s,
was “made in the ordinary course of business” and for “an adequate and full
consideration in money or money’s worth.” Sec. 25.2512-8, Gift Tax Regs.
– 31 –
[*31] We do not find this argument persuasive. There is no evidence that any dispute
existed in 1971-1972 concerning ownership of Sumner’s stock or that Mickey
was determined to withhold any of Sumner’s shares from him. To the contrary:
the evidence showed that Mickey and Sumner were working in concert to drive Edward
out of the company and that the “oral trust” theory was a weapon they deployed
against Edward in an effort to achieve that goal. Because no demand was
ever placed on Sumner’s shares, no negotiations ever occurred concerning his
ownership of those shares. Sumner never filed a lawsuit, and he received no
release of claims from Mickey (or anyone else) upon transferring his stock.
We likewise discern no convincing evidence that Sumner’s transfer “facilitated
the settlement of his brother’s litigation.” The Settlement Agreement had
been finally executed three weeks before Sumner made his transfer. The Settlement
Agreement does not mention any prospective transfer of stock by Sumner,
and there is no documentary evidence that his promise to make such a transfer was
a condition precedent to the Settlement Agreement. By its terms, the Settlement
Agreement imposed no obligations on Sumner except that he execute releases in
exchange for reciprocal releases from each of the other parties.5
5In contending that Edward’s litigation “was resolved by both Edward and
* * * [Sumner] agreeing to transfer 16 2/3 shares of NAI stock to each of their
– 32 –
[*32] Petitioner’s transfer of stock to his children was undoubtedly prompted by
the Settlement Agreement, both as to its timing and its terms, and this transfer
surely pleased Mickey by ensuring the financial security of his four grandchildren
on equal terms. But this is not enough to make it a transaction “in the ordinary
course of business.” Pleasing parents, like pleasing children, is presumptively a
family motivation, and we discern no evidence tending to rebut that presumption
here. There was no claim against Sumner; there were no arm’s-length negotiations;
and he received no consideration from anyone in exchange for his transfer.
In transferring stock to the Brent and Shari Trusts, Sumner was essentially
motivated by the kinship that he had with his father and his children. Sumner was
the sole trustee of both his children’s Trusts; there is no evidence that he was
children,” petitioner relies on a statement in a 2004 deposition by Mr. DiGiacomo.
When asked to explain how the 1971-1972 dispute was resolved, he stated: “It
was resolved by Eddie being deemed the owner of two-thirds of the shares. That
is my best recollection. And the other one-third was to be divided between
Michael and Ruth Ann. And their shares were held under a trust. Eddie’s shares
were redeemed by the corporation, and I believe the same applied to Sumner. In
other words, Sumner’s children had the same proportionate ownership, and that’s
how the matter was resolved.” Mr. DiGiacomo noted in his 2004 deposition that
he was providing a high-level summary of distant events of which he had imperfeet
recollection: “[T]his matter goes back awhile, looking at the file this morning,
some of it comes back to me, but without having looked at the file, it would not
have.” Neither Sumner, Mr. DiGiacomo, nor any other witness in the instant case
testified that a promise by Sumner to transfer stock to the Brent and Shari Trusts
was a condition precedent to execution of the Settlement Agreement.
– 33 –
[*33] reluctant to effect this transfer or that it disadvantaged him from a business
perspective.6 The transfer thus bears all the indicia of donative intent toward the
natural objects of his affection.
Sumner’s testimony in the O’Connor case firmly supports these conclusions.
He testified repeatedly, both in deposition and at trial, that his 1972 transfer of
stock was completely voluntary. He stated that he “voluntarily went through the
same procedure” as his brother and “gave * * * [his] own children” the stock. He
explained: “I wanted to do the same thing that my brother did, only he did it as a
result of litigation. I did it voluntarily.” He testified similarly at trial: “I gave my
kids a third of the stock voluntarily, not as a result of a lawsuit. In [s]o doing, I did
what I wanted and appeased my father too.” He emphasized that his shares, unlike
Edward’s, were “unencumbered” by any litigation claims: “Eddie was sued. I was
not. * * * I just made an outright gift.”
We find that Sumner’s 1972 transfer of stock to the Brent and Shari Trusts
was “actuated by love and affection.” C[ Beveridge, 10 T.C. at 918; Estate of
6By contrast, Edward was clearly reluctant to transfer stock to his own
children’s Trusts; for one thing, Sumner, rather than he, was the sole trustee of
those Trusts. Both economic and family reasons motivated Edward to insist on
securing outright ownership of (or payment for) all 100 shares that were originally
registered in his name. See Estate of Redstone, 145 T.C. at __ (slip op. at 25 &
– 34 –
[*34] Noland v. Commissioner, T.C. Memo. 1984-209, 47 T.C.M. (CCH) 1640,
1644-1645. His transfer was animated by donative intent and was not a transaction
“made in the ordinary course of business” within the meaning of section 25.2512-8,
Gift Tax Regs. It was therefore a taxable gift for Federal gift tax purposes.7
“If the gift is made in property, the value thereof at the date of the gift shall
be considered the amount of the gift.” Sec. 2512. The fair market value of
property is the price at which it would change hands between a willing buyer and a
willing seller, neither being under any compulsion to buy or sell and both having
reasonable knowledge of relevant facts. Sec. 25.2512-1, Gift Tax Regs.; see Rev.
Rul. 59-60, 1959-1 C.B. 237. The valuation of property is a question of fact. M
Tallichet v. Commissioner, T.C. Memo. 1974-255.
In valuing shares of a closely held corporation, “actual arm’s-length sales of
such stock in the normal course of business within a reasonable time before or after
7Petitioner contends that his transfer was made in the ordinary course of
business because he thereby “poised himself to become NAI’s majority shareholder.”
But Sumner had already become NAI’s majority shareholder as a result
of the Settlement Agreement; his decision three weeks later to transfer 33 1/3 of
his 100 shares to his children’s Trusts did nothing to enhance his majority position.
This transfer could be deemed causally related to his achievement of majority
status only if it were a condition precedent to execution of the Settlement
Agreement. As explained in the text, we find no convincing evidence that it was.
– 35 –
[*35] the valuation date are the best criteria of market value.” Estate of Andrews v.
Commissioner, 79 T.C. 938, 940 (1982). Where actual sale prices are unavailable,
stock may be valued by reference to “the company’s net worth, prospective earning
power and dividend-paying capacity, and other relevant factors.” Sec. 25.2512-
2(f), Gift Tax Regs. These factors cannot be applied with mathematical precision;
the weight given various factors depends on the particular facts of each case.
Estate of Andrews, 79 T.C. at 940-941.
In deciding valuation issues we may consider the opinions of expert witnesses
properly admitted into evidence. Helvering v. Nat’l Grocery Co., 304 U.S.
282, 295 (1938). Ifwe find one expert’s opinion persuasive in its entirety, we may
accept his opinion in preference to the opposing expert’s. See Buffalo Tool & Die
Mfg. Co. v. Commissioner, 74 T.C. 441, 452 (1980). Alternatively, we may reach
“an intermediate conclusion as to value” by drawing selectively from the testimony
of various experts. Parker v. Commissioner, 86 T.C. 547, 562 (1986).
- Petitioner’s Expert
Employing the so-called engrafting method, Mr. Klein valued the shares
petitioner transferred in July 1972 by reference to the price NAI paid to redeem the
Trusts’ shares in March 1984. Since value is determined as of a specific date,
“[o]nly facts reasonably known at the valuation date may serve as the basis for
– 36 –
[*36] valuation.” Estate of Newhouse v. Commissioner, 94 T.C. 193, 218 (1990).
But later occurring events, including later occurring sales of stock, “may be taken
into account as evidence of fair market value as of the valuation date.” Estate of
Jung v. Commissioner, 101 T.C. 412, 431. As a rule, stock transactions post-dating
the valuation date are probative only if they occur “within a reasonable time * * *
after the valuation date.” Estate of Andrews, 79 T.C. at 940; see Estate of Scanlan
- Commissioner, T.C. Memo. 1996-331, 72 T.C.M. (CCH) 160, 162 (considering
offers to purchase stock made more than 18 months after the valuation date),©
without published opinion, 116 F.3d 1476 (5th Cir. 1997); Jayson v. United States,
294 F.2d 808, 810 (5th Cir. 1961) (considering as not too remote a transaction
occurring 3 1/2 years after the valuation date). Petitioner has cited no case in
which a court employed, as its principal valuation metric, a stock sale that occurred
as many as 12 years after the valuation date.
Ifwe assume arguendo that the 1984 redemption price could be used to determine
the value of NAI stock in July 1972, various adjustments would have to be
made to take account of changes wrought by the passage of time. These would include
“changes in general inflation, people’s expectations with respect to that industry,
performances of the various components of the business, technology, and
the provisions of tax law that might affect fair market values.” Estate of Jung, 101
– 37 –
[*37] T.C. at 431-432; Estate of Scanlan, 72 T.C.M. (CCH) at 163. Here,
adjustments between 1972 and 1984 might be required for differences in macroeconomic
factors (such as inflation, interest rates, and stock market values),
industry-specific factors (such as changes in the movie industry), and companyspecific
factors (such as changes in the mix of NAI’s assets or lines of business).
When implementing his valuation methodology, Mr. Klein made no adjustment
of any kind to account for differences between the macro-economic, industryspecific,
and NAI-specific conditions prevailing in 1984 and those prevailing in
- And he provided no rationale for failing to make these adjustments, stating:
“I considered the need for normalization adjustment based on the available data.
None came to mind.” His failure to make (or to show the absence of a need to
make) relevant adjustments renders his report altogether unreliable. We thus have
no need to decide whether his “engrafting method” is an acceptable method of
valuing closely-held company stock;8 whether the 1984 redemption was too remote
from the July 1972 valuation date to constitute probative evidence; or whether the
3Respondent’s expert, Mr. Hastings, opines that the “engrafting method” is
not a recognized method of valuing corporate stock. Mr. Klein argues that his
method, which employs a ratio between the 1984 redemption price and NAI’s net
income, resembles the “direct capitalization” method.
– 38 –
[*38] price NAI paid to redeem the Trusts’ stock in 1984, contrary to the contentions
of the O’Connor plaintiffs, was determined at fair market value.
- Respondent’s Expert
Respondent’s expert, Mr. Hastings, based his valuation of NAI stock as of
July 21, 1972, primarily on the price that NAI paid to redeem Edward’s stock on
June 30, 1972. Mr. Hastings opined that the $5 million price NAI agreed to pay
Edward was negotiated at arm’s length, was essentially contemporaneous with
Sumner’s transfer, and yielded a value of $75,000 per NAI common share.
We agree with Mr. Hastings. The transaction by which NAI redeemed Edward’s
shares occurred “within a reasonable time before * * * the valuation date.”
Estate of Andrews, 79 T.C. at 940. It thus reflected market conditions approximating
those prevalent three weeks later when Sumner made his gift. In Estate of
Redstone, 145 T.C. at __ (slip op. at 22-23), we concluded that the Settlement
Agreement pursuant to which NAI redeemed Edward’s stock was the result of
arm’s-length bargaining among Mickey, Sumner, and Edward. The price at which
Edward’s stock would be redeemed was a central element of this bargaining, and
we conclude that it, in particular, was negotiated at arm’s length.
Mickey, Sumner, and Edward were NAI’s three principals. They had
worked for NAI for decades and were thoroughly familiar with its financial con-
[*39] dition and prospects. Edward had an economic interest in getting paid as
much as possible for his shares, and Sumner and Mickey had an economic interest
in paying him as little as possible. All three were represented by counsel, and they
negotiated this point for more than a year. We find that the outcome of this
negotiation–a per-share price of $75,000–represented the fair market value of NAI
common stock as of the valuation date. This yields a value of $2.5 million for the
33 1/3 shares that Sumner transferred to the Brent and Shari Trusts.
- Petitioner’s Arguments
Petitioner advances four arguments in support of his submission that the
price NAI paid Edward is not a reliable index of NAI’s stock value. First, he
contends that the June 30, 1972, redemption transaction cannot be employed under
the regulations because Edward and NAI were “under * * * [a] compulsion to buy
or sell.” See sec. 25.2512-1, Gift Tax Regs. According to petitioner, Mickey and
NAI were under a compulsion to buy Edward’s shares “because they wanted to
prevent Edward from selling his stock to an outsider”; and Edward was under a
compulsion to sell because he was supposedly under financial strain.
We find no evidence that the transaction by which NAI redeemed Edward’s
stock was in any sense a “forced sale.” C[ Heiner v. Crosby, 24 F.2d 191 (3d Cir.
1928) (noting that “forced sales” do not signify fair market value). The parties did
– 40 –
[*40] not act in haste; they negotiated for six months before Edward filed his
lawsuits and for another six months thereafter. See Estate of Sharp v.
Commissioner, T.C. Memo. 1994-636, 68 T.C.M. (CCH) 1521, 1525 (finding that
the existence of business disputes between the selling parties did not mean they
“were under any ‘compulsion’ to sell”). All parties were experienced businessmen,
and all had the assistance of able counsel. The leisurely pace of their negotiations
suggests that neither side felt compelled to act. As often in litigation, each side
held some leverage over the other because of the latter’s circumstances. But this
does not mean that either was compelled to act. Quite the contrary is true: the
possession of leverage over one’s opponent is often an incentive to hold out rather
than to capitulate.
Second, petitioner points out that Edward did not receive the $5 million redemption
price in cash. Rather, he received from NAI a $5 million note payable in
quarterly installments over 10 years. Petitioner contends that Edward actually received
proceeds worth less than $5 million because NAI’s note bore interest at a
“below market * * * rate.”
There is no factual support for this argument. Edward’s note bore interest at
the “floating prime rate” charged by the Boston bank from which NAI had obtained
most of its financing. NAI’s financial statements show that its third-party borrow-
[*41] ings were generally effected at the prime rate. Since the prime rate is the rate
at which NAI borrowed from its institutional lenders, it was an arm’s-length
interest rate that fully compensated Edward for the time value of money and the
risk of nonpayment.
Third, petitioner contends that the $5 million redemption price compensated
Edward, not only for surrendering 66 2/3 shares of NAI stock, but also for executing
releases of the claims he held against NAI, Mickey, and Sumner. We find no
merit in this argument. The Settlement Agreement and the Redemption Agreement
specifically provided that NAI would purchase Edward’s 66 2/3 shares for $5 million,
i.e., that this consideration was being paid exclusively for his stock. The releases
were provided for separately in the Settlement Agreement. Under section 9
thereof, Mickey, Sumner, NAI, and Edward each released all claims in consideration
of the other parties’ reciprocal release of claims.
Petitioner has supplied no reason to believe that the releases that he, Mickey,
and NAI provided to Edward were less valuable than the releases that Edward provided
to them. For example, Mickey originally claimed that the “oral trust” covered
half of Edward’s 100 shares, whereas Edward claimed outright ownership of
all 100 shares. Mickey and Edward released their respective claims pursuant to a
compromise by which Edward was deemed the outright owner of 66 2/3 shares.
– 42 –
[*42] With respect to this and other claims, it is impossible to determine whose
release was more valuable because the case was settled rather than tried. Assuming
as we do that the parties rationally evaluated their respective hazards of litigation,
we conclude that the releases each party provided were equivalent in value to the
releases that each party received?
Finally, petitioner argues that the price NAI paid to redeem Edward’s shares
was inflated by a control premium because it “positioned petitioner to obtain control
of NAI.” We likewise reject this argument. NAI executed the Redemption
Agreement with Edward; logically, it would not have paid a “control premium” to
acquire its own shares. Sumner had fiduciary duties to NAI’s other shareholders,
including the beneficiaries of the Grandchildren’s Trust, of which he was a trustee.
We will not assume that Sumner, in order to advance his own interest, breached his
fiduciary duties by causing NAI to pay Edward more than his shares were worth.
°Petitioner urges that we ascribe value to Edward’s agreement to “have nothing
further to do with the business or affairs of” NAI. But Edward had voluntarily
left his employment at NAI nearly a year before the Settlement Agreement
was executed. He made no claims in the NAI Action for damages based on the
manner in which his employment ended. In the O’Connor litigation, petitioner
agreed that the stock Edward had transferred to his children’s Trusts was properly
valued at $75,000 per share; he did not contend that the proceeds Edward received
included compensation for release of employment or other claims.
– 43 –
[*43] Instead, we accept Mr. Hastings’ conclusion that NAI would have agreed to
pay Edward no more than the amount he would have received by selling his shares
to an unrelated third-party buyer. Far from including a control premium, this
amount would incorporate a discount for a lack of marketability, which presumably
is reflected in the $5 million redemption price that the parties negotiated at arm’s
length.¹° There is no evidence that Sumner caused NAI to pay a premium of any
kind to acquire Edward’s shares.
In sum, we find that the redemption price NAI paid Edward on June 30,
1972, is a reliable index of the stock’s value on July 21, 1972, when Sumner made
his gifts. Because we find this actual arm’s-length transaction to be the best indicator
of fair market value, see Estate of Andrews, 79 T.C. at 940, we find it unnecessary
to examine the results that could be generated under the “direct capitalization”
and “guideline public company” methods, which Mr. Hastings alternatively
employed. (After applying a discount for lack of marketability, he determined
¹°Petitioner appears to accept this analysis when he agrees that a 34% lackof-
marketability discount should be applied under the direct capitalization method
and the guideline public company method, but not under the mergers and acquisitions
method (which is exactly how Mr. Hastings applied the discounts). A discount
for lack of marketability was not required under the mergers and acquisitions
method in this case because it was already factored into the $5 million
– 44 –
[*44] under these approaches values of $2,433,608 and $2,997,054, respectively,
for the 33 1/3 transferred shares.)
The parties disagree about numerous inputs into these other methodologies,
including NAI’s cost of equity, the appropriate “beta,” the company’s expected
growth rate, and the universe of comparable companies. These disagreements are
not surprising because the valuation date was 43 years ago, the data available from
public databases and NAI’s own records are inadequate, and it is difficult to find
companies comparable to NAI in 1972, which was then (rather incongruously) an
entertainment company with much of its value tied up in real estate. Suffice it to
say that the $2.5 million valuation we have determined on the basis of the June
1972 redemption price falls comfortably within the range of values that can be
generated using various permutations of these other formulas.
III. Additions to Tax
- Addition to Tax for Fraud
Respondent contends that petitioner is liable under section 6653(b) for an
addition to tax for fraud. Respondent bears the burden of proving fraud by clear
and convincing evidence. See Goldberg v. Commissioner, 239 F.2d 316, 320 (5th
Cir. 1956), rev’g T.C. Memo. 1954-242. Respondent contends that his “assertion
of the fraud penalty is based on petitioner’s complete failure to explain why, given
– 45 –
[*45] that he knew that there was no preexisting oral trust, * * * [he] did not report
this gift and pay gift tax.”
Respondent has not met his burden of proof. The oral trust may have been a
fiction, but it was a fiction with real-world consequences. Mickey passionately
believed in the “oral trust” theory and, at his insistence, it became a central feature
of the Settlement Agreement by which Edward’s litigation was resolved. To please
his father, Sumner adopted the same “oral trust” terminology when making a symmetrical
transfer to his own children. There is no evidence that Sumner embraced
the “oral trust” concept in an effort to evade his Federal gift tax liabilities.
- Other Additions to Tax
Respondent alternatively contends that petitioner is liable for additions to tax
under section 6651(a)(1) for failure to file a gift tax return and under section
6653(a) for negligence. In 1972 the Code imposed a 5% addition to tax on any
underpayment attributable to “negligence or intentional disregard of rules and
regulations.” See sec. 6653(a). The question of negligence is one of fact upon
which the taxpayer has the burden of proof. Marcello v. Commissioner, 43 T.C.
168, 182 (1964), aff’d in part, remanded in part, 380 F.2d 499 (5th Cir. 1967). A
taxpayer may show that his failure to file a return was not negligent if he relied in
good faith on advice from a tax professional that no tax liability existed or that no
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[*46] return was required. See Commissioner v. Am. Ass’n of Eng’rs Emp’t, Inc.,
204 F.2d 19 (7th Cir. 1953) (no addition to tax where taxpayer was advised by a
reputable tax attorney that he did not have to file a return); Haywood Lumber &
Mining Co. v. Commissioner, 178 F.2d 769, 771 (2d Cir. 1950).
We find that petitioner made the requisite showing of a reasonable cause
defense for both additions to tax. Mr. Rosen, Mr. Isenberg, and the tax
professionals at J.K. Lasser were competent tax advisers. Collectively, they
advised Sumner about his gift tax filing requirements on 34 occasions beginning in
- Sumner sought and received their advice concerning the tax consequences
of transferring stock to the Brent and Shari Trusts. The evidence established that
Mr. Rosen obtained advice from J.K. Lasser’s national office about this
transaction; that this advice was memorialized in a letter or memorandum
concluding that no gift tax return was required to be filed; that Messrs. Rosen and
Isenberg concurred in this conclusion; and that Sumner relied on this advice in
good faith. We conclude that petitioner is not liable for an addition to tax for
negligence or for failure to file a gift tax return.
– 47 –
[*47] To reflect the foregoing,
Decision will be entered for
respondent as to the deficiency and for
petitioner as to the additions to tax.