Estate of McLendon v. Commissioner
This text of 1993 T.C. Memo. 459 (Estate of McLendon v. Commissioner) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
*469 Decision will be entered under Rule 155.
G was diagnosed with esophageal cancer in May 1985. Although G's condition initially improved following radiation therapy, the cancer recurred in September 1985. From October 1985 through April 1986, G received six courses of an investigational form of chemotherapy treatment. These treatments were temporarily interrupted when G attempted suicide in December 1985. Although G was found to be in "endoscopic complete remission" as of Nov. 30, 1985, the cancer again recurred in May 1986.
Subsequent to the original diagnosis of cancer, G amended two family partnership agreements in which G was a general partner. In one instance, the partnership agreement was amended to allow G to transfer his partnership interest without causing the partnership to liquidate. Both partnership agreements were amended to state that upon G's death or disability, G's son, B, would have sole managerial control of the partnerships. On Mar. 5, 1986, G (as annuitant) entered into a private annuity agreement with B and the McLendon Family Trust (a trust that G established for each of his three daughters) as obligors. Under this agreement, the obligors agreed to purchase*470 a remainder interest in certain of G's assets (including G's two general partnership interests) for an annuity payable over G's lifetime. The remainder interest was valued under
MEMORANDUM FINDINGS OF FACT AND OPINION
HAMBLEN,
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| Deficiency | 6651(a)(1) | 6651(a)(2) | 6653(a)(1)(A) | 6653(a)(1)(B) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| $ 31,142,507 | $ 7,785,627 | 1 | $ 1,557,125 | Free access — add to your briefcase to read the full text and ask questions with AI ESTATE OF GORDON B. MCLENDON, DECEASED, GORDON B. MCLENDON, JR., INDEPENDENT EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; ESTATE OF GORDON B. MCLENDON, DECEASED, DONOR, GORDON B. MCLENDON, JR., INDEPENDENT EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Estate of McLendon v. Commissioner Docket Nos. 20324-90, 20325-90 T.C. Memo 1993-459; 1993 Tax Ct. Memo LEXIS 469; 66 T.C.M. (CCH) 946; September 30, 1993, Filed *469 Decision will be entered under Rule 155. G was diagnosed with esophageal cancer in May 1985. Although G's condition initially improved following radiation therapy, the cancer recurred in September 1985. From October 1985 through April 1986, G received six courses of an investigational form of chemotherapy treatment. These treatments were temporarily interrupted when G attempted suicide in December 1985. Although G was found to be in "endoscopic complete remission" as of Nov. 30, 1985, the cancer again recurred in May 1986. Subsequent to the original diagnosis of cancer, G amended two family partnership agreements in which G was a general partner. In one instance, the partnership agreement was amended to allow G to transfer his partnership interest without causing the partnership to liquidate. Both partnership agreements were amended to state that upon G's death or disability, G's son, B, would have sole managerial control of the partnerships. On Mar. 5, 1986, G (as annuitant) entered into a private annuity agreement with B and the McLendon Family Trust (a trust that G established for each of his three daughters) as obligors. Under this agreement, the obligors agreed to purchase*470 a remainder interest in certain of G's assets (including G's two general partnership interests) for an annuity payable over G's lifetime. The remainder interest was valued under For petitioner: For respondent: HAMBLEN HAMBLEN MEMORANDUM FINDINGS OF FACT AND OPINION HAMBLEN,
*472 Respondent now concedes that petitioner is not liable for the addition to tax under 6651(a)(2). Respondent further determined a deficiency in and additions to petitioner's Federal estate tax as follows:
After concessions by both parties, the issues left to be decided are: (1) The fair market value on March 5, 1986, of Gordon B. McLendon's general partnership interests in Tri-State Theaters Limited Partnership and McLendon Co.; (2) whether it was proper for Gordon B. McLendon to apply the actuarial tables set forth in FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Gordon B. McLendon (Gordon or decedent) died testate on September 14, 1986, survived by four children from his marriage to Gay Noe McLendon: Gordon B. McLendon, Jr. (Bart), Kristen Margaret McLendon (Kristen), Anna Gray McLendon (Anna), and Jan McLendon Moss (Jan). At the time of his death, *474 Gordon resided in the State of Texas. Bart is the sole executor of Gordon's estate. I. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| General Partners | Interest |
| Gordon | 30 percent |
| Bart | 10 percent |
| Limited Partners | |
| B.R. | 30 percent |
| Jeanette | 30 percent |
B.R. and Jeanette died on October 11, 1982, and July 25, 1985, respectively. Following their deaths, their estates elected to retain their interests in Tri-State. On March 5, 1986, partnership interests in Tri-State were held as follows:
| General Partners | Interest |
| Gordon | 30 percent |
| Bart | 10 percent |
| Limited Partners | |
| Estate of B.R. McLendon | 30 percent |
| Estate of Jeanette McLendon | 30 percent |
The Tri-State partnership agreement allowed for Tri-State to engage in a broad range of business activities including movie theater operations, real estate development, oil and gas exploration and development, and investment in stocks, bonds, and other securities. During 1986, Tri-State's principal business activities were limited to the leasing of real estate for drive-in theater operations and the management of its investments. Its principal assets consisted of real estate and marketable securities.
As of 1986, Gordon had withdrawn from*489 active management of Tri-State and Bart assumed more responsibility in this regard. Tri-State had no employees of its own and relied on the staff of an affiliate, the McLendon Co., for administrative assistance.
2. Transfer Restrictions
Article IX of the original Tri-State limited partnership agreement sets forth restrictions on the transfer of an interest in the partnership. Article IX, paragraph 9.02, states in pertinent part:
(a) any Partner may make a testamentary transfer of all or any part of his interest in the Partnership to any individual, entity or trustee; provided, in the case of a testamentary transfer of a general partnership interest, such testamentary transfer shall be subject to paragraph 9.04 of this Article; * * * * (c) The death of Gordon B. McLendon, bankruptcy of Gordon B. McLendon*491 * * *, insanity of Gordon B. McLendon * * *, or the assignment or encumbrance of Gordon B. [McLendon's] interest in violation of this Agreement.
Article XI of the Tri-State limited partnership agreement states that the agreement may be amended from time to time by agreement of a majority in interest of the general and limited partners.
3. Amendments to the Tri-State Limited Partnership Agreement
On May 30, 1985, Gordon and his mother, Jeanette, executed amendments to the Tri-State limited partnership agreement. In particular, the second sentence of article IX, paragraph 9.04, was amended to provide that the passing of a general partner's interest to his legal representatives upon his death would not be treated as an event of default. Further, article X, paragraph 10.01(c) (providing for the dissolution and liquidation of the partnership upon Gordon's death, bankruptcy, or insanity, or upon an assignment of his partnership interest in violation of the agreement), was deleted from the agreement in its entirety. Bart was initially unaware that the Tri-State agreement had been amended in this fashion.
On August 23, 1985, Gordon and Bart executed further amendments to *492 the Tri-State limited partnership agreement. Gordon and Bart executed the amendments both as general partners and as the legal representatives of the estates of B.R. and Jeanette McLendon. Article VII, paragraph 7.01, and all related provisions of the original limited partnership agreement were amended to state that, upon Gordon's death or disability, Bart would have sole and exclusive management, supervision, and control of the partnership and its assets. In addition, new paragraph 7.06 was added to the agreement, stating that Bart would have the authority to expel from the partnership any partner who might institute legal proceedings against him or otherwise contest his managerial decisions. Finally, article X, paragraph 10.01, of the original limited partnership agreement was amended to add new subsection (c), which states: (c) Except as hereinabove provided, each Partner hereby irrevocably waives the power to dissolve and terminate the Partnership and the right to seek a court decree of dissolution and termination and/or partition of the Partnership assets.
B. The McLendon Co.
By partnership agreement dated November*493 20, 1972, Gordon and his parents, B.R. and Jeanette, joined as general partners to form a Texas general partnership known as the McLendon Co. (McLendon Co.). The partnership was formed in part for the purpose of assuming the business theretofore conducted by McLendon Corp., a Texas corporation then in liquidation. In this regard, the original partnership agreement states that McLendon Co. would be capitalized through a transfer of substantially all of the assets of McLendon Corp. Prior to its liquidation, the McLendon Corp. was engaged in the operation of radio stations and movie theaters.
The original McLendon Co. partnership agreement states that responsibility for the management of McLendon Co. would rest with B.R. and Gordon. McLendon Co. had four employees including an accountant, two clerks, and a secretary.
During the period in question, McLendon Co. operated primarily as an investment company holding real estate, ancient coins, antiquities, and short-term money market funds. Income consisted primarily of rental income from the leasing of real estate for the operation of drive-in movie theaters as well as interest and dividend income. McLendon Co. owned a six-screen*494 drive-in movie theater facility in Houston, Texas, the buildings and equipment associated with six other drive-in movie theaters in Houston, Dallas, and El Paso, Texas, and an indoor movie theater in Dallas, Texas. McLendon Co. leased these movie theaters to FLW Theatre Co. (FLW) which had complete responsibility over operations.
McLendon Co. also owned a number of antiques and artifacts consisting of ancient Sumerian clay tablets and Mesopotamian, Assyrian, Babylonian, and Akkadian cylinder stamp seals, ancient statues, and oriental carpets and rugs. McLendon Co. held minority interests in tax oriented limited partnerships and a leasehold interest for the use of an undeveloped island off the coast of Australia.
At the time of the formation of the partnership, the partners' interests in the capital and net profits and losses of the partnership were as follows:
| Partner | Interest |
| B.R. | 50 percent |
| Gordon | 49 percent |
| Jeanette | 1 percent |
Section 6 of the original McLendon Co. partnership agreement states in pertinent part: The managing partners shall be B.R. McLendon and Gordon B. McLendon. Jeanette McLendon shall have no voice in the*495 management of the partnership business and need devote no time thereto. * * * No partner shall, except with the consent of the other partners, assign, mortgage, grant a security interest in, or sell his share in the partnership or in its capital assets or property, or enter into any agreement as a result of which any person shall become interested with him in the partnership.
3. Transactions Affecting Ownership
*496 Following the deaths of B.R. and Jeanette in October 1982 and July 1985, respectively, the partnership continued with the successors in interest of each of their estates. As a consequence of a division of the interests of B.R. and Jeanette pursuant to the community property laws of Texas, each estate held a 25.5-percent interest in McLendon Co.
In August 1985, Gordon assigned a 3-percent interest in the McLendon Co. to his son, Bart. 3 There is no indication in the record that the remaining partners, specifically the estates of B.R. and Jeanette McLendon, formally consented to the assignment to Bart.
4.
On August 23, 1985, Gordon and Bart executed amendments to the McLendon Co. partnership agreement that in substance mirrored*497 the amendments to the Tri-State partnership agreement adopted the same day. Again, Gordon and Bart executed the amendments both as general partners and as the legal representatives of the estates of B.R. and Jeanette McLendon. The amendments state in pertinent part: In order to provide strong, effective, consistent management for and thereby protect and preserve the assets of THE MCLENDON COMPANY, * * * the undersigned, being all of the current partners of the Partnership and having agreed and hereby agreeing, pursuant to Section 10 of the Partnership Agreement, to continue the Partnership with the successors in interest of B.R. McLENDON and JEANETTE McLENDON, both deceased, do hereby amend the Partnership Agreement as follows: I. Section 6 of the Partnership Agreement is hereby amended as follows: A. The first two sentences of such Section 6 are hereby deleted in their entirety and there is hereby substituted for such deleted sentences the following sentences: "Upon the death or disability of Gordon B. McLendon, the sole and exclusive managing partner of the partnership shall be GORDON B. McLENDON, JR., who, acting alone and in his full and complete discretion, shall *498 have the sole and exclusive right to manage the partnership and the partnership business. No other partner shall either have a voice in the management of a partnership business or be required to devote any time thereto * * *. B. There shall be added to such Section 6 a second paragraph which shall read as follows: "Should any partner contest by legal action, judicial proceeding or otherwise any management decision or action made or taken by the managing partner in his role as sole and exclusive manager of the partnership business, then the managing partner may, by written notice to such partner * * * expel such partner from the partnership, such expulsion and the termination of such partner's status as a partner in the partnership being effective as of the date of the Expulsion Notice. No such expulsion shall cause a dissolution and termination of the Partnership and, upon any such event, no one shall have the right to compel the termination and liquidation of the Partnership.
C. Janet Pallas
Janet Pallas (Pallas), an accountant, began preparing partnership returns for Tri-State and McLendon Co. in 1983 while employed as a manager with Peat Marwick Mitchell. Pallas was hired by Tri-State and McLendon Co. in December 1985. During this period, Pallas also represented Bart, Anna, and Kristen and was privy to the details surrounding the family's financial and business matters. Pallas presently serves as chief financial officer for both Tri-State and McLendon Co.
Pallas was present at a meeting in August 1985, during which some of the previously described amendments to the Tri-State and McLendon Co. partnership agreements were adopted. Pallas believed that the amendments were adopted for the primary purpose of ensuring that the partnerships would continue in an orderly fashion with Bart firmly in control. From Pallas' perspective, the amendments reflected Gordon's concern that his daughters did not possess the business acumen needed to manage the partnerships. Pallas was also aware that Gordon's daughters had caused discord within the family by bringing a lawsuit against their maternal grandparents' estates. Finally, Pallas*500 believed that Gordon was concerned that the executors named in his mother's will, including his former wife, were not prepared to act in the best interests of the partnerships.
IV. Last Will and Testament
Gordon executed his last will and testament on October 24, 1985, naming Bart independent executor. 4 The will states in pertinent part:
SECTION II I direct that all of my automobiles, clothing, jewelry, objects of art, china, linens, furniture, silverware, and all other purely personal effects and tangible personal property owned by me shall be divided by my executor among my children and lineal descendants, in such proportions (and to the total or partial exclusion of one or more members of such group should my executor so determine) and on such terms and conditions as my executor may in his sole discretion determine. I give and assign my membership in the Dallas Country Club, Dallas, Texas, to my son, GORDON B. McLENDON, JR., but if he is not living at that time, then to his eldest living son. SECTION III (a) To Billie P. Odom, the sum of $ 750,000.00 * * *. If she does not survive me, this bequest shall pass to her children and lineal descendants, per stirpes. (b) To my sister, Marie McLendon May Wheeler, if she survives me, the sum of $ 250,000.00 * * *. If she does not survive me, this bequest shall pass to her children and lineal descendants, per stirpes. SECTION IV Four-fifths (4/5) of the rest and residue of my estate of every character and description, and wheresoever situated, shall be distributed for the uses and purposes and subject to the terms, provisions and limitations hereinafter set forth: (a) These assets shall be divided into four equal parts, and, if necessary also an equal part for the descendants, taken collectively, of any child of mine who shall have predeceased me. One part shall be distributed to my son GORDON B. McLENDON, JR. outright and free of trust. The remaining three parts shall be designated by the name of each daughter of mine and shall be held in a separate and distinct trust and administered for the benefit of that child and her lineal descendants, or if a daughter is not surviving, *502 then for the benefit of her lineal descendants. Each trust shall be held and administered by GORDON B. McLENDON, JR. as Trustee. (b) The Trustee shall distribute at his sole discretion to each of my daughters in whose name a trust is created, and the descendants of such child, so much of the net income and corpus of that trust as the Trustee determines necessary for her support and maintenance in the station in life and the standard of living to which she has become accustomed during my lifetime, and in any event, to maintain and support her in health, including medical, dental, hospital and nursing expenses, and expenses of invalidism, taking into consideration, however, all other sources of income which she may or should have. (c) Each trust shall terminate and be distributed to that child upon the following dates: one-fourth (1/4) of each child's trust, including accumulated income and corpus, upon the death of GBM or in any event not later than two (2) years after the date of death; one-third (1/3) of the remaining assets in each trust shall be distributed to that child seven (7) years after the date of death; one-half (1/2) of the remaining assets in each trust shall be distributed*503 to that child twelve (12) years after the date of death; and all the remaining assets in each trust shall be distributed to that child seventeen (17) years after the date of death. SECTION V The remaining one-fifth (1/5) of the rest and residue of my estate of every character and description, and wheresoever situated, shall be held in trust for the uses and purposes and subject to the terms, provisions and limitations hereinafter set forth: (a) This portion of my estate shall be divided into as many equal parts as there are children of mine living at my death, and also an equal part for the descendants, taken collectively, of any child of mine who shall have predeceased me. Each of said parts shall be designated as the children's trust of each child of mine and shall be held as a separate and distinct trust and administered for the benefit of the children of each of my children and for said grandchild's lineal descendants. Each of said trusts shall be held and administered by GORDON B. McLENDON, JR. as Trustee.I give, devise and bequeath the following:
Section IX of the will states that if a beneficiary contests the will or otherwise attempts to attack, modify, or impair its validity, that beneficiary's *504 sole inheritance from Gordon's estate will be $ 1 in lieu of any other provision made for that beneficiary under the will.
V. Private Annuity Agreement and Related Transactions
A. The Private Annuity Agreement
On March 5, 1986, Bart (as both grantor and trustee) executed an irrevocable trust agreement entitled the McLendon Family Trust Agreement (McLendon Family Trust). The trust agreement establishes a separate and distinct trust for each of Gordon's three daughters: Jan, Kristen, and Anna. Mandatory and discretionary distributions from the trusts are in all material respects identical to the distribution scheme set out in section IV of Gordon's last will and testament. The trust agreement names MBankDallas, N.A. (MBank), as successor trustee in the event that Bart is unable to serve as trustee.
Like section IX of Gordon's will, article X, paragraph H, of the trust agreement states that if any of the beneficiaries contests Bart's authority or institutes any type of legal action against Bart, the beneficiary's rights under the trust will immediately lapse and transfer to the remaining beneficiaries.
On March 5, 1986, Gordon, as annuitant, entered into a private*505 annuity agreement with Bart (individually) and the McLendon Family Trust as obligors. Specifically, Gordon agreed to transfer a remainder interest in certain of his assets to the obligors in consideration for the obligors' promise to pay Gordon $ 250,000 at the time of the execution of the agreement, with the balance of the agreed purchase price to be paid in annual installments on the anniversary date of the agreement for the rest of Gordon's life. Under the agreement, 25 percent of the remainder interest would be purchased and owned outright by Bart individually, and 75 percent of such remainder interest would be purchased and held by the McLendon Family Trust for the benefit of Gordon's daughters.
Exhibit A attached to the private annuity agreement lists the assets subject to the agreement as follows: (1) A 30-percent general partnership interest in Tri-State; (2) a 46-percent general partnership interest in McLendon Co.; (3) all of the outstanding shares of Gordon B. McLendon, Inc.; (4) 20 acres, more or less, of undeveloped land situated in Denton County, Texas; and (5) all of Gordon's rights in the McLendon Co. pension plan. Exhibit A establishes a deadline of July 1, 1986, *506 for the appraisal of the assets listed therein.
The private annuity agreement includes a paragraph allowing for a future adjustment to the amount to be paid to Gordon as follows: The parties hereto recognize that the valuation of many of the assets set out on attached Exhibit A are, by their nature, as determined by the best judgement of the parties and independent consultants engaged to assist in the valuation process and may be subject to differing opinions. Therefore, the parties agree that, to the extent any of the values on the attached Exhibit A are changed through a settlement process with the Internal Revenue Service, or a final decision of the United States Tax Court, the purchase price hereunder shall be adjusted accordingly, with interest on said adjustment at the rate of ten percent (10%) from the date hereof until said final determination of value, and the annuity payments due and payable hereunder shall likewise be adjusted to reflect any such change in valuation.
The private annuity agreement was amended June 30, 1986, to extend the deadline for the appraisal of the assets in question to September 30, 1986. The amendment was signed by Bart as attorney in fact*507 for Gordon, as trustee of the McLendon Family Trust, and in his individual capacity.
B. The Annuity Computation
The parties to the private annuity agreement assigned an aggregate value of $ 18,362,970 to the five assets listed in exhibit A. Gordon's partnership interests in Tri-State and McLendon Co. were valued at $ 9,500,000 and $ 4,200,000, respectively. The record does not reflect the specific values assigned to the remaining three assets.
Gordon was 65 years old on March 5, 1986, giving him an actuarial life expectancy of 15 years on the date the private annuity agreement was executed. The amount to be paid to Gordon under the private annuity agreement was calculated by first computing the present value of a remainder interest in the assets in question. This was accomplished by multiplying $ 18,362,970 (the value assigned to the assets listed in exhibit A) by .32030 (the factor prescribed by
C. Financing and Related Correspondence
On March 6, 1986, Anderson Wallace, Jr. (Bart's attorney), advised James M. Spellings (Spellings) of MBank that in his opinion Bart was capable of borrowing funds from the McLendon Co. in order to fund the private annuity agreement. By letter dated March 14, 1986, Spellings notified Bart that MBank had approved his request for a loan on behalf of the McLendon Family Trust in the amount of $ 1,125,000 for the purpose of acquiring a remainder interest in Gordon's assets. By letter of the same date, Spellings notified Bart that he would receive a loan of $ 375,000 in his individual capacity for the same purpose.
By letter dated July 3, 1986, Bart wrote to Spellings regarding the repayment of a loan the proceeds of which were used to satisfy Bart's one-quarter share of the $ 250,000 paid to Gordon at the time the private annuity agreement was consummated. The letter states in pertinent part: At this time, I desire to pay the principal balance, $ 62,500.00, of note number 149041. As you know, this note relates to certain estate planning undertaken earlier this year involving*509 my purchase of a remainder interest in my father's assets. Since the purchase is essentially, in lieu of my receiving an inheritance upon my father's death, the note is a separate obligation on my part. Accordingly, Jim, I am directing you to debit my separate funds in satisfaction of the obligation. * * *
On or about September 8, 1986, Bart and the McLendon Family Trust transferred $ 600,000 to Gordon.
D. Gordon's Federal Income Tax Return
Gordon's final Federal income tax return (for the short year ending September 14, 1986) was filed on October 14, 1987, pursuant to an extension. The return reflects a total tax liability of $ 1,493,848, including tax on ordinary income and long-term capital gain attributed to the above-described private annuity transaction. 5
*510 VI.
Shortly after Gordon's death in September 1986, Bart and Anderson Wallace, Jr., attended a meeting in Newport Beach, California, with Bart's three sisters and their attorney, Don Killian. Bart called the meeting after learning that his sisters were preparing to institute legal proceedings in an effort to force Tri-State and McLendon Co. to liquidate. Bart hoped to avoid such litigation by explaining to his sisters why their father had planned his estate as he did.
The meeting in Newport Beach proved unsuccessful for shortly thereafter Anna and Jan brought an action against the Estate of Jeanette McLendon, McLendon Co., and Tri-State in the Probate Court of Dallas County, Texas. The action was brought to contest the validity of the August 23, 1985, amendments to the Tri-State and McLendon Co. partnership agreements. In its judgment signed November 5, 1991, the probate court ruled in pertinent part that: (1) The McLendon Co. did not dissolve upon the death of Jeanette McLendon and that there are no other grounds for its dissolution; and (2) the August 23, 1985, amendments to the Tri-State and McLendon Co. partnership agreements are valid. (At the*511 time this matter was submitted to the Court, the judgment of the probate court was on appeal. In its judgment entered August 17, 1993, the Texas Court of Appeals (an intermediate appellate court) affirmed the probate court respecting the validity of the partnership amendments).
VII. Petitioner's Federal Estate Tax Return
Petitioner filed its Federal estate tax return (Form 706) on or about June 11, 1987, reporting a total gross estate of $ 3,554,390 and deductions of $ 1,704,791, leaving a taxable estate of $ 1,849,599. 6 Adjusted taxable gifts of $ 355,220 are reported in the return.
The total gross estate figure is derived from the total of the items listed on Schedule C (mortgages, notes, and cash), Schedule D (insurance on the decedent's life), and Schedule F (other miscellaneous property) attached to the return. The most significant item included within the total gross estate figure is $ 3,287,875 listed as a receivable*512 from McLendon Co. under Schedule C. The return also includes Schedule I (annuities) which states in pertinent part: Decedent was receiving private annuity payments from his four children prior to his death. These payments terminated on decedent's death and no further payments were paid or were payable to any other person or beneficiary.
Deductions against the total gross estate are derived from the total of the items listed on Schedule J (funeral expenses and expenses incurred in administering property subject to claims) and Schedule K (debts of the decedent, and mortgages and liens) attached to the return. Schedule K indicates that Gordon owed $ 100,471 each to Bart and the three individual trusts established under the McLendon Family Trust reflecting overpayments of principal and interest under the private annuity agreement.
VIII. Deficiency Notices
A. Deficiency Notice (Gift Tax)
Respondent determined a deficiency in and additions to petitioner's Federal gift tax for the 1986 taxable year. The deficiency in gift tax is attributable to respondent's determination that the private annuity*513 transaction was in substance part sale and part gift. The deficiency notice states in pertinent part:
(A) It is determined that on or about March 5, 1986, the decedent made transfers which are subject [to] the gift tax as follows:
| Property Transferred: | |
| 30-percent general partnership interest | |
| in Tri-State Theaters, a limited partnership | $ 43,940,952 |
| 46-percent general partnership interest | |
| in the McLendon Co., a general partnership | 11,375,516 |
| 1,000 shares of Gordon McLendon, Inc. | 200,000 |
| 20 acres of real property in Denton County, | |
| Texas | 280,000 |
| Decedent's interest in the McLendon Co. | |
| Pension Trust | 4,182,970 |
| Less: | |
| Value of retained life estate | $ 2,726,335 |
| Consideration paid by donees | 250,000 |
| Value of Gift | $ 57,003,103 |
It is further determined that no exclusions are allowable since the transfer were of a future interest. Accordingly, the amount of taxable gifts is $ 57,003.103.
A portion of the gift tax deficiency is also attributable to respondent's determination that Gordon made prior taxable gifts of $ 873,754. In particular, respondent determined that the fair market value of the 3-percent general partnership interest in McLendon Co. that Gordon transferred*514 to Bart in August 1985 was $ 873,754, rather than $ 355,220 as reported by Gordon on his Federal gift tax return for the calendar year ending December 31, 1985. 7
Respondent now contends that as of March 5, 1986, the aggregate fair market value of the assets that were the subject of the private annuity agreement was $ 51,562,970. This lower figure is attributable to a reduction in the values assigned to the Tri-State and McLendon Co. partnership interests to $ 37,800,000 and $ 9,100,000, respectively. On the other hand, respondent stands by the values determined in the deficiency notice with respect to the Gordon McLendon, Inc. stock, the 20 acres of land, and Gordon's interest in the McLendon Co. pension trust. Petitioner has presented no evidence to counter respondent's determination with respect to these latter three items, and thus petitioner is deemed to have conceded those values.
In determining*515 the value of the taxable gift resulting from the private annuity transaction, respondent proposes to subtract from $ 51,562,970 the value of the life estate that Gordon retained in the assets, as well as the $ 250,000 paid to Gordon at the time the transaction was consummated. Relying on the views articulated by her medical and actuarial experts, respondent contends that the value of Gordon's life estate should be determined by computing the value of an income interest in $ 51,562,970 for a term certain of .65 years.
Petitioner does not contest respondent's determination that the remainder interest transferred pursuant to the private annuity transaction is properly characterized as a future interest. Consequently, if respondent's position is sustained, petitioner is not entitled to exclude any portion of the resulting gift under section 2503(b).
B. Deficiency Notice (Estate Tax)
As indicated, respondent also determined a deficiency in and additions to petitioner's Federal estate tax. The deficiency in estate tax is based on respondent's determination that: (1) Petitioner failed to report as part of the gross estate the $ 250,000 paid to Gordon concurrently with the execution*516 of the private annuity agreement; (2) the private annuity transaction resulted in a transfer properly included in Gordon's gross estate pursuant to
Respondent now fully concedes*517 items 1 and 3 listed above. With respect to item 4, respondent now concedes that petitioner is entitled to a deduction from the gross estate of $ 401,884 reflecting amounts overpaid under the private annuity agreement. With respect to item 5, respondent concedes that the correct value of the 3-percent general partnership interest transferred to Bart is $ 479,568, reducing the proposed increase in adjusted taxable gifts to $ 124,348. 9
IX. Stipulated Values
The parties have stipulated several alternative values for Gordon's Tri-State and McLendon Co. partnership interests as of March 5, 1986, and September 14, 1986.
A. Tri-State
Assuming that a transferee of Gordon's interest in Tri-State is treated as having received a partnership interest and that the 1985 amendments to the partnership agreement are respected, the parties agree that there are *518 three alternative bases for computing the value of the interest: The expulsion scenario, the default scenario (rights exercised), and the default scenario (rights not exercised).
Under the expulsion scenario, a partner expelled pursuant to article 7.06 of the partnership agreement as amended August 23, 1985, is to be paid the existing book value of his income and capital account. Payment will be made in 10 equal installments at an annual rate of 10 percent. Under this approach, the fair market value of Gordon's interest in Tri-State on March 5, 1986, and September 14, 1986, is $ 3,600,000.
Under the default scenario (rights exercised), a defaulting partner under article 9.04 of the partnership agreement as amended May 30, 1985, is to be paid the book value of his income and capital accounts as of the date of default. Under this approach, the fair market value of Gordon's interest in Tri-State on March 5, 1986, and September 14, 1986, is $ 5,900,000.
Under the default scenario (rights not exercised), a defaulting partner is entitled to sell his interest at fair market value if the remaining partners do not exercise their rights under article 9.04 of the partnership agreement as*519 amended May 30, 1985, to purchase the interest at book value. Under this approach, the fair market values of Gordon's interest in Tri-State on March 5, 1986, and September 14, 1986, are $ 13,400,000 and $ 12,800,000, respectively.
Assuming that a transferee of Gordon's interest in Tri-State is treated as having received an assignee interest (as opposed to an outright partnership interest), the parties agree that the fair market value of Gordon's interest in Tri-State on March 5, 1986, and September 14, 1986, is $ 3,600,000.
Assuming that the amendments to the Tri-State partnership agreement are not respected for purposes of applying the Federal estate or gift tax and that the Court finds that a transferee of Gordon's interest would have the right to liquidate the partnership, the parties agree that the fair market values of Gordon's interest in Tri-State on March 5, 1986, and September 14, 1986, are $ 37,800,000 and $ 36,200,000, respectively.
B. McLendon Co.
Assuming that a transferee of Gordon's interest in McLendon Co. is treated as having received a partnership interest and that the August 23, 1985, amendment to the partnership agreement is respected, the parties agree*520 that there are four alternative bases for computing the value of the partnership interest: The expulsion scenario, purchase rights exercised scenario, purchase rights not exercised scenario, and sale to a third party scenario.
Under the expulsion scenario, a partner expelled pursuant to section 6 of the partnership agreement as amended August 23, 1985, is to be paid the existing book value of his income and capital account. Payment will be made in 10 equal installments at an annual rate of 10 percent. Under this approach, the fair market values of Gordon's interest in McLendon Co. on March 5, 1986, and September 14, 1986, are $ 3,900,000 and $ 3,800,000, respectively.
Under the purchase rights exercised scenario, the retirement or death of a partner leaves the remaining partners with the right to purchase that partner's interest for an amount equal to the partner's capital account, increased by his share of partnership profits or decreased by his share of partnership losses for the particular year. The purchase price is to be paid without interest in 4 semi-annual installments beginning 6 months after the date of retirement/death. Under this approach, the fair market values *521 of Gordon's interest in McLendon Co. on March 5, 1986, and September 14, 1986, are $ 5,600,000 and $ 5,500,000, respectively.
Under the purchase rights not exercised scenario, the managing partner is permitted to either terminate and liquidate the partnership or continue the partnership with a successor in interest of a retiring or deceased partner in the event the remaining partners do not exercise their right to purchase the interest of the retiring/deceased partner. Under this approach, the fair market value of Gordon's interest in McLendon Co. on March 5, 1986, and September 14, 1986, is $ 9,100,000.
Under the sale to a third party scenario, a partner may sell his interest in the partnership with the consent of the remaining partners pursuant to section 6 of the original McLendon Co. partnership agreement. Under this approach, the fair market value of Gordon's interest in McLendon Co. on March 5, 1986, and September 14, 1986, is $ 5,100,000.
Assuming that a transferee of Gordon's interest in McLendon Co. is treated as having received an assignee interest (as opposed to an outright partnership interest), the parties agree that the fair market values of Gordon's interest in *522 McLendon Co. on March 5, 1986, and September 14, 1986, are $ 3,900,000 and $ 3,800,000, respectively.
X. Medical Experts
The parties filed expert reports and presented expert testimony concerning Gordon's physical condition and actual life expectancy on March 5, 1986.
A. Dr. Freireich
Dr. Freireich prepared an expert report evaluating Gordon's physical condition both prior and subsequent to March 5, 1986. Dr. Freireich testified on petitioner's behalf at trial.
Dr. Freireich earned his M.D. degree from the University of Illinois College of Medicine in 1949. Since 1965, Dr. Freireich has served as internist and professor of medicine at the University of Texas M.D. Anderson Cancer Center in Houston, Texas. From 1973 through 1981, Dr. Freireich served as the chief of the oncology division at the University of Texas Medical School in Houston, Texas.
In Dr. Freireich's opinion, the cure rate for a cancer patient with Gordon's medical history as presented in October 1985, i.e., locally recurrent cancer following radiation therapy, would be approximately 2 to 3 percent. However, in light of Gordon's favorable response to the investigational chemotherapy treatment and*523 the resulting endoscopic remission of the cancer, Dr. Freireich stated that he would have been unable to predict as of March 1986 whether Gordon's cancer would recur. 10 Dr. Freireich also concluded that Gordon did not exhibit any clinical signs of imminent death on March 5, 1986. Although Dr. Freireich admitted that Gordon's condition could be compared to that of some of his other patients, he declined to offer an opinion as to Gordon's actual life expectancy as of March 5, 1986.
Dr. Freireich's report states in pertinent part: His first therapy was given on October 5, 1985. By the time he received his second course of treatment, his swallowing had improved and the x-ray revealed partial response. Prior to his third treatment, we were*524 impressed that there was complete disappearance of his disease both on x-ray and by endoscopic examination of the esophagus. At that point we were extremely optimistic that a substantial, potentially long-lasting response would be achieved in his instance with this innovative treatment. His fourth admission here was on January 9, 1986, following the gunshot wound to his head. At that point he had still no evidence of recurrence of his disease and I personally found that his attitude was even more optimistic than it was before the accident. Therefore, we administered his fourth course of treatment in January, a fifth course in February and a sixth course in March. It was clear to me that he accepted the additional treatment designed to intensify the response we already observed, in hopes that his disease free period would be prolonged for a substantial period of time. In February, 1986, he wrote me a letter and asked me to state formally what his future would be and it was on February 19, 1986, that I wrote him a rather explicit letter telling him as matter-of-factly as I could what his prospects for survival were. I would direct your attention to this letter for additional *525 information regarding my opinion as to Mr. McLendon's prospects for survival. 11
It is Dr. Freireich's philosophy that a physician should not give a patient a hopeless prognosis, and to the extent he can, he should give him an optimistic prognosis.
Dr. Freireich did not review Gordon's records prior to the trial of this matter and as a consequence was not fully prepared to testify. For instance, Dr. Freireich initially testified that he was unaware that Gordon suffered from paralysis of the left vocal cord. Later in his testimony, Dr. Freireich stated (contrary to the known facts) that Gordon's vocal cord paralysis was attributable to Gordon's "accident" and was not related to his cancer.
B. Dr. Fleischman
Dr. Roger A. Fleischman (Dr. Fleischman) prepared an expert report evaluating Gordon's physical condition as of March 5, 1986, and testified on respondent's behalf at trial. Dr. Fleischman received both a Ph.D. and an M.D. *526 degree from Harvard Medical School in 1975 and 1976, respectively, and has trained in the specialties of internal medicine, hematology, and oncology. Since 1983, Dr. Fleischman has served as an assistant professor of internal medicine at the University of Texas Southwestern Medical Center in Dallas, Texas.
As a preliminary matter, Dr. Fleischman disagrees with the statement in Dr. Freireich's letter to Gordon dated February 19, 1986, characterizing the possibility that Gordon's cancer was permanently eradicated as "definite and significant". In Dr. Fleischman's view, this statement conflicts with Dr. Freireich's opinion of a 2 to 3 percent cure rate for patients with Gordon's history. Further, Dr. Fleischman believes that the statement was intended to provide a psychological benefit to Gordon by providing him with a hopeful outlook, but that such a statement was not realistic given Gordon's condition.
Dr. Fleischman views the chemotherapy treatment that Gordon received as being largely palliative in the sense that the cancer would inevitably recur and cause Gordon's death. Consistent with Dr. Freireich's views, Dr. Fleischman opined that one could predict, with a greater than*527 95 percent likelihood, that Gordon would not be cured of his cancer. Dr. Fleischman agreed with Dr. Freireich that Gordon did not exhibit any clinical signs of imminent death on March 5, 1986.
Dr. Fleischman's report states in pertinent part: Thus, at the time of March 5, 1986, Mr. McLendon was in a remission, as judged by the last endoscopy done at the end of November [1985] and the absence of dysphagia, or difficulty swallowing. However, without question, small amounts of the cancer were still present in the esophagus at this time, and recurrence of symptoms and death were inevitable and predictable. Essentially no one with this type and extent of esophageal cancer, and a prior failure with radiation treatment, is curable with chemotherapy alone. The treatment is intended to be palliative, and extend life in those who respond well for a total of 6-12 months, with only rare cases living longer than this. Thus, (1) I would first conclude that as of March 5, 1986, the decedent's condition was clearly (2) Although in my opinion the decedent would be considered terminal as of March 5, 1986, his death could not be considered impending within weeks or a few months. Clearly, a remission in this disease can occasionally last longer than the average, and up to 15% of cases similar to the decedent's might still be alive at one year, and up to 5% at two years after achieving the remission. (3) Given these figures, on March 5, 1986, when Mr. McLendon had already been in remission for six months, I would estimate the likelihood of his death within one year to be greater than 90%. On the other hand, the decedent's death was not clearly impending within a year's time with absolute certainty, as a small number of cases, again less than 10% of similar cases, might still survive beyond a year. (4) However, the decedent's death was predictable to the extent that I have already indicated. By this I mean that the patient could be told with a fair degree of accuracy*529 that having achieved a remission with chemotherapy, on March 5, 1986, now 6 months into this remission, the life expectancy would be less than a year with a 90% likelihood. On the other hand, there was a small chance, that I estimate at about 1 in 10 that the patient would still be alive in one year's time, albeit almost certainly with recurrent tumor and worsening symptoms that would progress to death in the subsequent months thereafter. Fewer than 1 in 20 patients would still be alive at two years, and those still alive would almost all be facing an impending death by that time.
OPINION
The issues to be resolved in this case relate to the proper transfer tax treatment of the private annuity transaction executed on March 5, 1986. Petitioner's liability for Federal gift tax turns primarily on the question of the fair market value of the remainder interest that Gordon transferred to Bart and the McLendon Family Trust and whether the transaction was based on an exchange of adequate and full consideration. In the event that we rule that the private annuity agreement resulted in a taxable gift, we are asked to decide whether a so-called saving clause included in the private annuity*530 agreement will be respected.
Petitioner's liability for Federal estate tax turns on the applicability of
I. Gift Tax
The value of a gift in property is determined as of the date of the gift.
A gift may result from a transaction where property is transferred for less than adequate consideration. (b) 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, and shall be included in computing the amount of gifts made during the calendar year. Transfers reached by*532 the gift tax are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts, but embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money's worth of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth. * * *
As indicated, the primary issue concerning petitioner's liability for Federal gift tax relates to the value of the remainder interest that Gordon transferred to Bart and the McLendon Family Trust pursuant to the private annuity agreement. First, however, we are asked to determine the fair market value of Gordon's general*533 partnership interests in Tri-State and McLendon Co. as of March 5, 1986 (the date the private annuity agreement was executed). Once the question of the fair market value of the partnership interests is resolved, we are asked to decide whether it was appropriate for Gordon to compute the value of a remainder interest in the assets that were made the subject of the private annuity agreement under the actuarial tables set forth in
A. Fair Market Value of the Partnership Interests
The parties have stipulated alternative values for Gordon's two partnership interests as follows:
| Tri-State | ||
| 3/5/86 | 9/14/86 | |
| Expulsion scenario | $ 3,600,000 | $ 3,600,000 |
| Default scenario (rights exercised) | 5,900,000 | 5,900,000 |
| Default scenario (rights not exercised) | 13,400,000 | 12,800,000 |
| Assignee scenario | 3,600,000 | 3,600,000 |
| Liquidation scenario | 37,800,000 | 36,200,000 |
| McLendon Company | ||
| 3/5/86 | 9/14/86 | |
| Expulsion scenario | $ 3,900,000 | $ 3,800,000 |
| Purchase rights exercised scenario | 5,600,000 | 5,500,000 |
| Purchase rights not exercised scenario | 9,100,000 | 9,100,000 |
| Sale to a third party scenario | 5,100,000 | 5,100,000 |
| Assignee scenario | 3,900,000 | 3,800,000 |
*534 As is often the case, the parties have taken extreme positions respecting the question of fair market value.
Respondent contends that the amendments to the partnership agreements, adopted in May and August 1985, after Gordon was diagnosed with esophageal cancer, should be disregarded in determining the value of Gordon's partnership interests as of March 5, 1986. Respondent asserts that the amendments lack a bona fide business purpose and were adopted for the primary purpose of allowing Gordon to transfer his property to his children for less than an adequate and full consideration. In the event that we sustain respondent's position on this point, respondent asserts that the fair market value of Gordon's partnership interest in Tri-State should be its liquidated value pursuant to paragraph 10.01(c) of the original Tri-State limited partnership agreement. 12
*535 Relying on the testimony of Pallas, petitioner argues that the partnership amendments were intended to serve the valid business purpose of ensuring the continuity of the partnerships while at the same time leaving exclusive management and control with Bart. Petitioner further asserts that there in no support in the record for the notion that the amendments were intended to serve as a testamentary device. Assuming that the partnership amendments are respected, petitioner takes the position that it is appropriate to value the interests in question as "assignee" interests. 13 Petitioner's valuation theory is premised in part on the proposition that the Tri-State and McLendon Co. partnership agreements did not proscribe or inhibit Gordon's transfer of a remainder interest in his partnership interests.
*536 We are not inclined to adopt either party's valuation theory. Simply stated, there is some evidence supporting petitioner's contention that the partnership amendments were adopted for the valid business purpose of assuring continued family management and control. See
Viewing the record as a whole, we are persuaded that the amendments were adopted in part for the purpose of achieving legitimate business objectives. Nonetheless, we cannot agree with respondent that we should disregard the amendments for purposes of determining the value of Gordon's partnership interests. We decline to adopt such an approach given that the partnerships were never in fact liquidated, and we believe the amendments served to limit the partners' ability to liquidate the partnerships.
Nor are we inclined to value the partnership interests on the assumption that Gordon was simply transferring "assignee" interests. Under the circumstances, we view*538 the private annuity agreement as a device intended to permit Gordon to transfer his partnership interests to the natural objects of his bounty for less than adequate and full consideration.
Initially, we note that there is no evidence that the private annuity agreement was negotiated at arm's length or that the parties attempted to bargain over the terms of the agreement. See
Equally important, and indicative of Gordon's disregard of the partnership agreements, we agree with respondent that Gordon's transfer of a remainder interest in his Tri-State partnership interest constituted a default under the Tri-State agreement. Without question, a sale by a partner of a remainder interest in his partnership interest constitutes a prohibited sale of "all or any part of his interest" in the partnership as plainly set forth in paragraph 9.04(c) of the Tri-State partnership*539 agreement. The effect of Gordon's transfer of a remainder interest in his McLendon Co. partnership interest is less clear. The language used in section 6 of the McLendon Co. partnership agreement is not as exacting as that used in the Tri-State agreement. Nevertheless, we conclude that the transfer in question was proscribed under the McLendon Co. agreement. We note that section 6 of the McLendon Co. agreement states in unambiguous terms that a partner may not assign his interest in the partnership or enter into any agreement as a result of which any person shall become interested with him in the partnership without the consent of the remaining partners. It is reasonable to construe this provision, standing alone, as prohibiting a partner from transferring a remainder interest in his partnership interest unless he first obtains the consent of the other partners. In any event, our interpretation of section 6 harmonizes with, and gives effect to, section 10 of the agreement which states that the surviving partners will have the option of purchasing a deceased partner's interest. 15 Reading sections 6 and 10 together, it seems inescapable that section 6 must be interpreted to *540 preclude a partner from transferring a remainder interest in his partnership interest. To read section 6 otherwise would render the surviving partners' option under section 10 largely meaningless.
We also find it significant that Bart, a general partner in both Tri-State and McLendon Co., effectively controlled the partnerships and served as attorney in fact for Gordon, as trustee of the McLendon Family Trust, and as a legal representative for his grandparents' estates. In light of the intrafamily nature of the transaction and Bart's position *541 of ultimate control, we conclude that as a practical matter the interests transferred by Gordon to Bart (individually and as trustee) were the equivalent of partnership interests. In sum, to hold that Gordon merely transferred "assignee" interests would be to exalt form over substance. See, e.g.,
This leaves us with the problem of attempting to determine a value for the two partnership interests within the confines of the parties' stipulation. Neither fits neatly within the stipulated values that we have been given.
Consistent with the foregoing discussion, we hold that the transfers effected pursuant to the private annuity agreement should be treated as a transfer of Gordon's two partnership interests with the apparent consent of the remaining partners. In this regard, it is appropriate to value the Tri-State interest based on the "default scenario (rights not exercised)" under which a defaulting partner is entitled to sell his interest at fair market value if the remaining partners do not exercise their rights under article 9.04 of *542 the partnership agreement as amended May 30, 1985, to purchase the interest at book value. The parties agree that under this scenario the fair market value of Gordon's interest in Tri-State on March 5, 1986, is $ 13,400,000.
Similarly, we conclude that it is appropriate to value the McLendon Co. interest based on the "sale to a third party" scenario under which a partner may sell his interest in the partnership with the consent of the remaining partners pursuant to section 6 of the original McLendon Co. partnership agreement. The parties agree that under this scenario the fair market value of Gordon's interest in McLendon Co. on March 5, 1986, is $ 5,100,000.
B. Fair Market Value of Remainder Interest
Consistent with the preceding discussion, the aggregate fair market value of the assets that were the subject of the private annuity agreement was $ 23,162,970 on March 5, 1986. 16 With this figure in mind, we next turn to the question of the fair market value of a remainder interest in those assets as of the same date. More specifically, we are concerned with whether Gordon properly applied the actuarial tables set forth in
(2) The present value of an annuity, life estate, remainder, or reversion determined under this section which is dependent on the continuation or termination of the life of one person is computed by the use of Table A in paragraph (f) of this section. * * *
The actuarial tables referred to above are provided as an administrative necessity and their general use has been approved by the courts.
Nonetheless, the courts have long recognized that the actuarial tables should not be applied in those "exceptional cases" where the result would be unreasonable.
Petitioner and respondent disagree whether the actuarial tables were properly applied in computing the value of the remainder interest transferred pursuant to the private annuity agreement. The crux of the dispute centers on whether Gordon's death was sufficiently certain as of March 5, 1986, to justify a deviation from the actuarial tables. At a more fundamental level, the parties disagree with respect to the specific legal standard to apply in resolving this issue.
Respondent contends that, as of the valuation date, the known medical facts concerning Gordon's esophageal cancer were sufficiently exceptional as to justify a *546 departure from the actuarial tables in valuing the remainder interest and the related annuity. Relying on
Petitioner counters that Gordon's death was not predictable with any degree of medical certainty on March 5, 1986. On this basis, petitioner contends that Gordon had no choice but to utilize the actuarial tables in carrying out the necessary computations under the private annuity agreement. Petitioner relies*547 on In view of recent case law, the resulting principle is as follows: the current actuarial tables in the regulations shall be applied if valuation of an individual's life interest is required for purposes of the federal estate or gift taxes unless the individual is known to have been afflicted, at the time of transfer, with an incurable physical condition that is in such an advanced stage that death is clearly imminent. Death is not clearly imminent if there is a reasonable possibility of survival for more than a brief period. For example, death is not clearly imminent if the individual may survive for a year or more and if such a possibility is not so remote as to be negligible. If the evidence indicates that the decedent will survive for less than a year, no inference should be drawn that death will be regarded as clearly imminent, because this question depends *548 on all the facts and circumstances.
To resolve the question of the applicability of the actuarial tables, it will be helpful to briefly review the cases and rulings in this area. 17 We begin with
*549 We agreed with the taxpayer that the surviving spouse's actual physical condition was controlling with respect to the valuation and that his actual life expectancy was not more than 1 year. We observed: The United States Supreme Court has said that in making a deduction for a remainder interest bequeathed to charity, such as is here under consideration, "the value thereof must be determined from data available at the time of the death of decedent."
We followed the
The
As a preliminary*552 matter, the court resolved that the revenue ruling cited by the Government was intended to apply where it is known that the taxpayer is suffering from a fatal, incurable disease, and the taxpayer's actual life expectancy is brief (in absolute terms) or death is imminent.
The court also rejected the Government's reliance on the
Departures from the tables are permitted, if at all, only where the result of using the tables is "unrealistic and unreasonable," Estate of Carl E. Weller, [* * *
Citing
*554 The issue we confront today has also been addressed by the U.S. Court of Appeals for the Fifth Circuit (the circuit to which an appeal would lie in this case) in
As was the case in
In analyzing the issue on appeal, the Fifth Circuit recognized as a preliminary matter that the presumptive correctness of the actuarial tables may be overcome where there is sufficient evidence regarding the actual life expectancy of the individual in question. Citing
It is only where the established facts are sufficient to justify a departure from the Regulations that exceptions are allowed. Such exceptions have been recognized, for instance, where the death of a life tenant is imminent or predictable. * * * [
*556 We conclude our survey of the cases with a brief mention of
In rejecting respondent's position, we distinguished the The evidence demonstrates that the decedent's death was not clearly imminent or predictable at the time she entered*557 into the annuity agreement. Only where death is imminent or predictable will departure from the tables be justified. See
The common theme of these cases is that the actuarial tables generally are to be respected unless the established facts show that the result under the tables is unrealistic or unreasonable. Consistent with the
With the foregoing as background, we look to the expert reports and the question of whether Gordon's actual life expectancy was so limited as to justify a departure from the actuarial tables in computing the value of the remainder interest in question. The opinion of an expert is admissible if it will assist the trier of *558 fact in resolving a fact in issue. See
The medical experts could not agree with respect to Gordon's actual life expectancy on March 5, 1986. Petitioner's expert, Dr. Freireich, impressed the Court with his credentials and expertise in oncology. However, he had not reviewed Gordon's medical records prior to trial and therefore was not fully prepared to testify. Dr. Freireich's lack of preparation was evident from his inconsistent testimony regarding the presence and significance *559 of Gordon's left vocal cord paralysis.
Although he admitted that the cure rate for patients with Gordon's condition would be limited to 2 to 3 percent, Dr. Freireich declined to offer an opinion respecting either Gordon's actual life expectancy or the likelihood that the cancer would recur. We cannot agree that there was no basis for Dr. Freireich to form an opinion on either point. In particular, in his letter to Gordon dated February 19, 1986, Dr. Freireich stated that he administered the same investigational treatment to several patients at M.D. Anderson with diagnoses similar to Gordon's. Further, Dr. Freireich was privy to studies and information from other cancer centers around the country that were conducting closely related programs. When questioned about the matter at trial, Dr. Freireich admitted that Gordon's condition could be compared with these other cases. We find it interesting that while Dr. Freireich characterized the results achieved under the particular chemotherapy treatment regimen as "most promising", petitioner made no effort to make the pertinent results part of the record in this case.
In contrast to Dr. Freireich, respondent's expert, Dr. Fleischman, *560 opined that Gordon's actual life expectancy probably would not extend beyond 6 months from March 1986, with death a virtual certainty within a year of that date. We note that Gordon followed the expected pattern and succumbed to the disease within 6 months of the valuation date. Dr. Fleischman based his opinion on a review of the history of Gordon's illness and past experience relating to the average remission in esophageal cancer cases. Considering the record as a whole, we are compelled to agree with Dr. Fleischman that Gordon's actual life expectancy on March 5, 1986, was quite limited.
We begin with the fact that Gordon's cancer recurred after extensive radiation therapy over the summer of 1985. By the time he was referred to Dr. Freireich in October 1985, his cancer was classified as systemic based upon the suspicion that the cancer had spread outside of the affected area. Further, the consensus among the treating physicians was that surgery was not an option for Gordon due to damage to the affected area resulting from the radiation therapy. The chances for a cure in Gordon's case were at best about 2 or 3 percent.
Although Gordon achieved an endoscopic complete remission*561 in November 1985, that fact alone does not convince us that Gordon's death was not imminent or predictable. First, there is no dispute that a remission based on an endoscopic examination is not the best standard for determining whether a cancer has been completely eradicated. Surgery generally is required to definitively establish that a cancer is completely eradicated. Unfortunately, surgery was not a viable option in Gordon's case. We are also persuaded by Dr. Fleischman's testimony that remissions in esophageal cancer are generally short lived. In addition, and perhaps more importantly, it strikes the Court as particularly suspect that no endoscopies were performed on Gordon between late November 1985 and May 1986, when the cancer was again detected. Both experts agree that, given the luxury of hindsight, it was obvious that Gordon's cancer was present as of March 5, 1986.
Further, Gordon's chemotherapy treatments were interrupted in December 1985, when Gordon attempted suicide. The suicide note left by Gordon indicates that he had relinquished any hope of surviving the cancer. Although Gordon failed in his suicide attempt, his physical condition was quite serious and *562 he continued to suffer from significant medical complications well after being released from the hospital. Gordon's mental state continued to be of concern from the time he first entered M.D. Anderson throughout the treatment period.
We give little weight to the correspondence between Gordon and Dr. Freireich in February 1986. While the initial letter from Gordon to Dr. Freireich (purportedly dictated by Gordon but not signed) gives the impression that Gordon was quite optimistic at the time, petitioner failed to establish that Gordon in fact dictated the letter. The letter was typed by "bpo" whom we surmise was Billie Odom, Gordon's secretary. Petitioner had ample opportunity to call Billie Odom as a witness to testify on the point but failed to do so. Under the circumstances, we assume that her testimony would have been damaging to petitioner's case.
In sum, the record as a whole paints a picture of an increasingly sick man suffering from a virtually incurable disease. Although Gordon's physical condition fluctuated from day to day, the overall trend was one of fairly rapid deterioration. Under the circumstances, we conclude that it was evident to all involved that Gordon was not likely to survive more than 1 year from March 5, 1986. 21 In light of Gordon's diminished actual life expectancy on the date that the private annuity agreement was executed, we hold that it was improper for Gordon to compute the value of the remainder interest in question under
*564 To briefly recapitulate, the parties to the private annuity agreement understated the full fair market value of the assets (including the two partnership interests) that were the subject of that agreement. As of March 5, 1986, the aggregate fair market value of the several assets in question was $ 23,162,970, compared with the $ 18,362,970 figure used by the parties to the agreement. Further, the value of a remainder interest in those assets was understated as a consequence of Gordon's use of the annuity tables in carrying out that computation. It necessarily follows that Gordon did not receive adequate and full consideration in exchange for the property interest that he transferred pursuant to the private annuity agreement.
Given the relationship of the parties to the private annuity agreement, a presumption arises that the difference in the consideration received by Gordon and the value of the property that he transferred represents a taxable gift. See
As previously discussed, the overwhelming sense of the Court is that Gordon entered into the annuity transaction solely for the purpose of achieving testamentary objectives. There is no evidence that the transaction was conducted at arm's length or that the parties attempted to bargain over the terms of the agreement. See
*566 Our conclusion that Gordon entered into the private annuity agreement primarily for the purpose of achieving testamentary objectives is also supported by Bart's July 3, 1986, letter to Spellings of MBank. Although the letter is subject to interpretation, we believe the letter reflects Bart's understanding that the private annuity agreement was structured as a substitute for a testamentary disposition of Gordon's assets.
In sum, we reject petitioner's contention that the private annuity transaction was a bona fide arm's-length transaction free from donative intent. We hold that petitioner is liable for Federal gift tax to the extent that the value of the remainder interest transferred by Gordon exceeds the $ 250,000 amount that Gordon actually received at the time the private annuity agreement was executed.
C. "Savings" Clause
The private annuity agreement includes a paragraph allowing for an adjustment to the amount to be paid to Gordon in the event that a higher value is assigned to the remainder interest through a settlement with the Internal Revenue Service or as a result of a final decision of this Court. The paragraph in question states: The parties hereto recognize*567 that the valuation of many of the assets set out on attached Exhibit A are, by their nature, as determined by the best judgement of the parties and independent consultants engaged to assist in the valuation process and may be subject to differing opinions. Therefore, the parties agree that, to the extent any of the values on the attached Exhibit A are changed through a settlement process with the Internal Revenue Service, or a final decision of the United States Tax Court, the purchase price hereunder shall be adjusted accordingly, with interest on said adjustment at the rate of ten percent (10%) from the date hereof until said final determination of value, and the annuity payments due and payable hereunder shall likewise be adjusted to reflect any such change in valuation.
Petitioner, relying on
Respondent counters that the Court should follow cases such as
In We do not think that the gift tax can be*569 avoided by any such device as this. Taxpayer has made a present gift of a future interest in property. He attempts to provide that, if a federal court of last resort shall hold the gift subject to gift tax, it shall be void as to such part of the property given as is subject to the tax. This is clearly a condition subsequent and void because contrary to public policy. A contrary holding would mean that upon a decision that the gift was subject to tax, the court making such decision must hold it not a gift and therefore not subject to tax. Such holding, however, being made in a tax suit to which the donees of the property are not parties, would not be binding upon them and they might later enforce the gift notwithstanding the decision of the Tax Court. It is manifest that a condition which involves this sort of trifling with the judicial process cannot be sustained. [
We followed
In rejecting the taxpayers' position in Furthermore, a condition that causes a part of a gift to lapse if it is determined for Federal gift tax purposes that the value of the gift exceeds a given amount, so as to avoid a gift tax deficiency, involves the same sort of "trifling with the judicial process" condemned in
Based upon our review of
Petitioner's reliance on
D. Additions to Gift Tax
Respondent determined that petitioner is liable for an addition*574 to gift tax under section 6651(a)(1). Section 6651(a) provides for an addition to tax where the taxpayer fails to file a timely return unless the taxpayer shows that such failure is due to reasonable cause and is not due to willful neglect. Respondent further determined that petitioner is liable for additions to gift tax under section 6653(a)(1) and (2), which provides for additions to tax if an underpayment of tax required to be shown on a return is due to negligence. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances.
Petitioner maintains that respondent erred in determining the above-described additions to gift tax on the ground that petitioner properly followed
We agree that petitioner's failure to file a gift tax return was due to reasonable cause. In particular, petitioner faced an uncertain and difficult question with respect to the applicability of the annuity tables. We are also *575 convinced that petitioner reasonably relied upon Gordon's attorney for an interpretation of
For the same reasons, we likewise conclude that petitioner is not liable for the additions to tax for negligence under section 6653(a)(1) and (2). In short, petitioner made a reasonable effort to ensure that its Federal gift tax liability was properly reported.
II. Federal Estate Tax
The Federal estate tax provides for a tax on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States.
The taxable estate is defined in
The transfer provision at issue in the case at hand is (a) General Rule. -- The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life*577 or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death -- (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.
(a) In General. -- If any one of the transfers, trusts, interests, rights, or powers enumerated and described in
Respondent determined that Gordon's retention of a life estate in the assets that were the subject of the private*579 annuity agreement results in the inclusion of those assets in his gross estate pursuant to
A. Section 2036(a)
The parties disagree with respect to the*580 proper interpretation of the parenthetical exception set forth in
*581 We need not address the parties' dispute over the proper interpretation of
There is no question that Gordon retained a life estate in (and the economic benefit of) the assets that were the subject of the private annuity agreement. Clearly, such a retained life estate falls within the intended scope of The phrase "an adequate and full consideration in money or money's worth" common to both the estate and gift tax statutes here pertinent, is to be given an "identical construction" in regard to each of them.
In order to determine the*583 fair market value of Gordon's partnership interests on the date of his death, we return to the parties' stipulation. With respect to Tri-State, we conclude that fair market value is best reflected under the "default scenario (rights not exercised)" under which a defaulting partner is entitled to sell his interest at fair market value in the event the remaining partners do not exercise their option rights. Under this approach, the fair market value of Gordon's interest in Tri-State as of September 14, 1986, is $ 12,800,000. With respect to McLendon Co., we believe that fair market value is best reflected under the "sale to a third party" scenario under which a partner may sell his interest with the consent of the remaining partners. Under this approach, the fair market value of Gordon's interest in McLendon Co. as of September 14, 1986, is $ 5,100,000. To the extent that petitioner did not contest the values determined by respondent with respect to the remaining assets that were the subject of the private annuity agreement, those values are deemed conceded. The aggregate of these amounts is includable in Gordon's gross estate pursuant to
B. Section 2043(a)
*584 Having resolved the
It was plainly designed to deal with the situation where the decedent has received some, but not "adequate and full" consideration for the transfer. In providing that there shall be included in the gross estate "only the excess of the fair market value at the time of death of the property * * * over the value of the consideration
Consistent with the foregoing, we hold that
C. Additions to Estate Tax
Respondent determined that petitioner is liable for additions to its Federal estate tax under section 6653(a)(1) and (2), which provides for additions to tax if an underpayment of tax required to be shown on a return is due to negligence. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances.
We have concluded that the fair market value of the assets that were made the subject of the private annuity agreement should have been included in the computation of the gross estate under
Footnotes
1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect on the date of Gordon B. McLendon's death. Rule references are to the Tax Court Rules of Practice and Procedure.↩
1. 25 percent of the amount shown as tax on a return specified in sec. 6651(a)(1).↩
2. 50 percent of the interest due on $ 31,142,507.↩
2. The initials "bpo" appear to belong to Billie P. Odom, Gordon's personal secretary. Petitioner did not call Odom to testify at trial or otherwise explain her absence.↩
3. It appears from a review of the notice of deficiency in estate tax that Gordon valued the 3-percent interest in the McLendon Co. at $ 355,220 and reported the transaction in a Federal gift tax return filed for the 1985 taxable year.↩
4. Gordon executed several versions of his last will and testament, including three versions between June and August 1985.↩
5. The parties agree that petitioner will be entitled to a refund of the Federal income tax attributable to the private annuity transaction to the extent, if any, that respondent prevails in the instant case. However, the matter of Gordon's Federal income tax is not before us and is irrelevant to the disposition of this case.↩
6. Petitioner's Federal estate tax return was prepared by Anderson Wallace, Jr.↩
7. Respondent now concedes that the correct value of the 3-percent general partnership interest is $ 479,568.↩
8. Respondent determined that the fair market value of the partnership interest was $ 873,754, rather than $ 355,220 as listed on the gift tax return for the calendar year ending Dec. 31, 1985. Accordingly, respondent increased adjusted taxable gifts by $ 518,534.↩
9. While petitioner assigns error to this particular item in its petition, petitioner did not otherwise contest the point, and thus it is deemed conceded.↩
10. Dr. Freireich believes that if a remission is achieved using an investigational form of cancer treatment, the treating physician can only conclude that the cancer will not recur because generally the physician will have no experience to call upon to conclude otherwise.↩
11. The full text of the February 1986 letter is set forth
supra↩ pp. 11-1312. While respondent makes a similar assertion with respect to McLendon Co., we note that the parties did not stipulate a liquidated value for McLendon Co. It appears to be respondent's position that the fair market value for McLendon Co. should be $ 9,100,000 under the purchase rights not exercised scenario.↩
13. Petitioner asserts that the interests that Gordon transferred are merely assignee interests based on
Tex. Rev. Civ. Stat. Ann. art. 6132b ,sec. 27(1) (1970), which provides in pertinent part:(1) A conveyance by a partner of his interest in the partnership does not of itself dissolve the partnership, nor, as against the other partners in the absence of an agreement, entitle the assignee, during the continuance of the partnership, to interfere in the management or administration of the partnership business or affairs; it merely entitles the assignee to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled and, for any proper purpose, to require reasonable information or account of partnership transactions and to make reasonable inspection of the partnership books.↩
14. See
infra↩ note 22.15. In
Park Cities Corp. v. Byrd , 534 S.W.2d 668, 672 (Tex. 1976)Southland Royalty Co. v. Pan Am. Petroleum Corp. , 378 S.W.2d 50, 53↩ (Tex. 1964)16. The $ 23,162,970 figure is derived by adding the fair market value of the partnership interests as determined above to the values of the remaining assets that were made the subject of the private annuity agreement, as follows:
↩ Tri-State general partnership interest $ 13,400,000 McLendon Co. general partnership interest 5,100,000 1,000 shares of Gordon McLendon, Inc. 200,000 20 acres of real property in Denton County, Texas 280,000 Gordon's interest in the McLendon Co. Pension Trust 4,182,970 23,162,970 17. Before reviewing the case law in this area, we will address petitioner's assertion that respondent's position in this case is somehow inconsistent or in conflict with
Rev. Rul. 80-80, 1980-1 C.B. 194↩ . The revenue ruling states that the actuarial tables are controlling unless the individual is known to have been afflicted, at the time of the transfer, with an incurable physical condition that is in such an advanced stage that death is clearly imminent. Generally, the question of whether death is clearly imminent is to be determined on the facts and circumstances of the particular case. The revenue ruling sets forth a limited and somewhat vague safe harbor: the actuarial tables may be used in cases where the individual may survive for a year or more and if the possibility of survival is not so remote as to be negligible. In light of the evidence presented regarding Gordon's medical condition, we find that it was reasonable for respondent to reject Gordon's use of the actuarial tables.18.
Rev. Rul. 80-80, 1980-1 C.B. 194 , was issued in part to clarifyRev. Rul. 66-307, 1966-2 C.B. 429↩ .19. In
Stillman v. Commissioner , T.C. Memo. 1965-94Estate of Jennings v. Commissioner , 10 T.C. 323↩ (1948)20. The Court of Appeals for the Fifth Circuit recently cited
Miami Beach First Natl. Bank v. United States , 443 F.2d 116 (5th Cir. 1971)Estate of Carter Through Taggert v. United States , 921 F.2d 63, 67↩ (5th Cir. 1991)21. Given contemporary advances in medicine and the ability to sustain life, we recognize that it is increasingly difficult to predict actual life expectancy with a high degree of certainty. We respect Dr. Fleischman's candor in admitting that Gordon's death could not be predicted with "absolute certainty". However, when a disease has progressed to such an extent as was present in the instant case, it becomes evident to those familiar with the physical condition of the patient that a cure cannot be expected and that death will inevitably follow.↩
22. As discussed in more detail below, the private annuity agreement includes a provision allowing for an adjustment to the amount to be paid to Gordon should the Internal Revenue Service or this Court determine a higher value for the remainder interest. We have observed in the past that such provisions allow for a reasonable inference that the transaction was not conducted at arm's length.
Harwood v. Commissioner , 82 T.C. 239, 271 n.23 (1984)786 F.2d 1174↩ (9th Cir. 1986) .23. We observed in
Ward v. Commissioner , 87 T.C. 78, 113 (1986)Commissioner v. Procter , 142 F.2d 824↩ (4th Cir. 1944)24.
Gradow v. United States , 11 Cl. Ct. 808 (1987)897 F.2d 516↩ (Fed. Cir. 1990) , has been the subject of much debate among legal commentators. Compare Dodge, 50-5th T.M., Transfers with Retained Interests and Powers, A-67 (1992) with 2 Casner, Estate Planning, sec. 6.15.2 n.6 (5th ed. 1985 & Supp. 1992).25. It appears that a similar issue arose in
Estate of De Foucaucourt v. Commissioner , 62 T.C. 485, 491↩ (1974)26. As previously discussed,
supra pp. 72-77sec. 2043(a)↩ .
Related
Cite This Page — Counsel Stack
1993 T.C. Memo. 459, 66 T.C.M. 946, 1993 Tax Ct. Memo LEXIS 469, Counsel Stack Legal Research, https://law.counselstack.com/opinion/estate-of-mclendon-v-commissioner-tax-1993.