Judges: "Wherry, Robert A."
Attorneys: John W. Porter, W. Donald Sparks II , and Michael R. Stein, for petitioner. Gerald A. Thorpe , for respondent.
Filed: May 26, 2005
Latest Update: Dec. 05, 2020
Summary: T.C. Memo. 2005-126 UNITED STATES TAX COURT ESTATE OF CHARLES PORTER SCHUTT, DECEASED, CHARLES P. SCHUTT, JR., AND HENRY I. BROWN III, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 19208-02. Filed May 26, 2005. S1 and S2, Delaware business trusts, were formed in 1998 and were capitalized by the contribution thereto of stock by D through a revocable trust and by WTC as trustee of various trusts created for the benefit of D’s children and grandchildren. At his
Summary: T.C. Memo. 2005-126 UNITED STATES TAX COURT ESTATE OF CHARLES PORTER SCHUTT, DECEASED, CHARLES P. SCHUTT, JR., AND HENRY I. BROWN III, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 19208-02. Filed May 26, 2005. S1 and S2, Delaware business trusts, were formed in 1998 and were capitalized by the contribution thereto of stock by D through a revocable trust and by WTC as trustee of various trusts created for the benefit of D’s children and grandchildren. At his ..
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T.C. Memo. 2005-126
UNITED STATES TAX COURT
ESTATE OF CHARLES PORTER SCHUTT, DECEASED,
CHARLES P. SCHUTT, JR., AND HENRY I. BROWN III, CO-EXECUTORS,
Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19208-02. Filed May 26, 2005.
S1 and S2, Delaware business trusts, were formed
in 1998 and were capitalized by the contribution
thereto of stock by D through a revocable trust and by
WTC as trustee of various trusts created for the
benefit of D’s children and grandchildren. At his
death in 1999, D held through the revocable trust a
45.236-percent interest in S1 and a 47.336-percent
interest in S2.
Held: D’s transfers of stock to S1 and S2 were
bona fide sales for adequate and full consideration
within the meaning of secs. 2036(a) and 2038, I.R.C.,
such that the value of the transferred assets is not
included in his gross estate under these statutes.
John W. Porter, W. Donald Sparks II, and Michael R. Stein,
for petitioner.
Gerald A. Thorpe, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: By a statutory notice dated October 11,
2002, respondent determined a Federal estate tax deficiency in
the amount of $6,113,583.03 with respect to the estate of Charles
Porter Schutt (the estate). By answer, respondent asserted an
increase in the deficiency of $1,409,884.65. Thereafter, by
amendment to answer, respondent asserted a further increase in
the deficiency of $3,595,513.32 (for a total deficiency of
$11,118,981). After concessions, the principal issue for
decision is whether the fair market value of stock contributed by
Charles Porter Schutt (decedent) through a revocable trust to
Schutt, I, Business Trust (Schutt I) and Schutt, II, Business
Trust (Schutt II) is includable in his gross estate pursuant to
section 2036(a) or 2038.1
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of the parties, with accompanying exhibits, are
incorporated herein by this reference. Decedent was a resident
of the State of Delaware when he died testate on April 21, 1999,
and his will was probated in that State. The co-executors of
1
Unless otherwise indicated, section references are to the
Internal Revenue Code (Code) in effect as of the date of
decedent’s death, and Rule references are to the Tax Court Rules
of Practice and Procedure.
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decedent’s estate both resided in the Commonwealth of
Pennsylvania at the time the petition in this case was filed.
General Background
Decedent was born on February 11, 1911. Decedent later
married Phyllis duPont (Mrs. Schutt), the daughter of Eugene E.
duPont (Mr. duPont). Decedent and Mrs. Schutt had four children,
each of whom subsequently married: Sarah Schutt Harrison,
Caroline Schutt Brown, Katherine D. Schutt Streitweiser, and
Charles P. Schutt, Jr. Decedent’s son Charles P. Schutt, Jr.,
and his son-in-law Henry I. Brown III are the co-executors of his
estate. Each of decedent’s four children had children of his or
her own, such that decedent and Mrs. Schutt were survived by 14
grandchildren.
Historically, a significant portion of the Schutt family
wealth has been invested in, and a concomitant significant and
steady portion of the family income has been generated by, an
interest in E. I. du Pont de Nemours and Company (DuPont) stock
and Phillips Petroleum Company stock initially obtained from
Mr. duPont. Throughout the decades, Mr. duPont, decedent, and
Mrs. Schutt have, in the administration of these and other
holdings, established a number of trusts for the benefit of
themselves and/or their issue.2 In the mid-1980s, the Schutt
2
Various trusts directly pertinent to the instant
litigation are described in detail infra in text. Decedent
(continued...)
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family’s holdings in Phillips Petroleum stock were sold, due to
dissatisfaction with the management of Phillips Petroleum, and
were replaced with stock in Exxon Corporation.
Trust 3044
During 1940, Mr. duPont as trustor and Wilmington Trust
Company (WTC) as trustee entered into a trust agreement dated
December 30, 1940 (Trust 3044). In accordance with this
agreement, shares of DuPont and Christiana Securities Company3
stock were placed in trust for the benefit of Mrs. Schutt and her
issue. As pertinent here,4 Trust 3044 provided that, until Mrs.
Schutt’s death, income was to be distributed quarterly to her
issue per stirpes, or if none to Mrs. Schutt.
Upon Mrs. Schutt’s death, the trust corpus was to be divided
into shares, per stirpes, for the benefit of her issue. If such
share was set aside for a living child of Mrs. Schutt, the corpus
so allocated was to be held in trust for the child and income
2
(...continued)
and/or Mrs. Schutt also established at least three additional
trusts during the 1970s for the benefit of their grandchildren
and the issue of their grandchildren.
3
Christiana Securities Company was a holding company
established by certain branches of the duPont family to hold
DuPont stock. The company was later merged into DuPont, and at
times relevant to this proceeding, the corpus of Trust 3044 (or
subtrusts thereunder) included DuPont and Exxon stock.
4
The following explanations in text of the various trusts
pertinent to this litigation are intended to serve as summaries
of the most salient provisions. The recitations do not attempt
to set forth every feature and/or contingency.
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therefrom was to continue to be distributed in quarterly
installments to the child. Upon the child’s death, the trustee
was to distribute the corpus free of trust to the child’s
descendants, per stirpes, subject to specified age restrictions.
As regards administration, Trust 3044 granted to the
trustee, subject to specified limitations, “in general, the power
to do and perform any and all acts and things in relation to the
trust fund in the same manner and to the same extent as an
individual might or could do with respect to his own property.”
Concerning limitations, the trust agreement provided for the
appointment of an “adviser of the trust” (also referred to herein
as a “consent adviser”) by Mrs. Schutt and stated that enumerated
powers granted to the trustee shall be exercised
only with the written consent of the adviser of the
trust; provided, however, that if at any time during
the continuance of this trust there shall be no adviser
of the trust, or if the adviser of the trust shall fail
to communicate in writing to Trustee his or her consent
or disapproval as to the exercise of any of the
aforesaid powers for which exercise the consent of such
adviser shall be necessary, within twenty days after
Trustee shall have sent to the adviser of the trust, by
registered mail, at his or her last known address, a
written request for such consent, then Trustee is
hereby authorized and empowered to take such action in
the premises as it, in its sole discretion, shall deem
to be for the best interest of any beneficiary of this
trust.
The specified powers subject to the above consent provision
were the trustee’s authority: (1) To sell or otherwise dispose
of trust property; (2) to hold cash uninvested or to invest in
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income-producing property; (3) to vote shares of stock held by
the trust; and (4) to participate in any plan or proceeding with
respect to rights or obligations arising from ownership of any
security held by the trust.
The trust agreement recited that any trust established
thereunder would terminate no later than 21 years after the death
of the last survivor of Mr. duPont, his then-living issue, and
his sons-in-law. At that juncture, any remaining principal was
to be distributed free of trust to the income beneficiaries
thereof at the time of the termination.
By a letter to WTC dated March 11, 1941, Mrs. Schutt
appointed Mr. duPont and decedent as advisers of Trust 3044. The
letter further stated that upon the death of either appointee,
the survivor would act as sole adviser until such time as
Mrs. Schutt appointed another adviser. Mr. duPont died on
December 17, 1966, and decedent remained as sole adviser with
respect to Trust 3044 and trusts created thereunder, a position
he continued to hold at the time of his own death on April 21,
1999.
Mrs. Schutt died on August 5, 1989. Upon her death, Trust
3044 was divided into separate trusts for the benefit of her four
children. These trusts are referred to as Trusts 3044-1, 3044-2,
3044-3, 3044-4, 3044-5, 3044-6, 3044-7, and 3044-8.
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Decedent’s and Mrs. Schutt’s daughter Katherine D. Schutt
Streitweiser died of leukemia on March 27, 1993. At that time,
she was the current beneficiary of Trusts 3044-3 and 3044-7. In
accordance with the provisions of those trusts, the assets held
therein were distributed outright to her children.
Trust 2064
Mrs. Schutt’s death was also significant with respect to the
structure of two additional trusts directly pertinent to this
litigation. By means of a trust agreement dated October 6, 1934,
between Mr. duPont and WTC, Mr. duPont conferred upon Mrs. Schutt
a limited power of appointment over what is referred to as Trust
2064. Under her will dated December 1, 1988, as amended by a
first codicil dated January 25, 1989, Mrs. Schutt exercised this
power of appointment. These documents provided that the property
subject to the power was to be held in trust by WTC. At
Mrs. Schutt’s death and after the distribution of $1,000 to each
of her surviving children, the balance of the trust was to be
divided into shares, with one share set aside for each surviving
grandchild and one share set aside for the then-living issue (as
a group) of any grandchild who predeceased her but left surviving
issue.
Any share set aside for a predeceased grandchild was to be
distributed free of trust to that grandchild’s issue, per
stirpes, subject to the minor’s trust provision set forth in the
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will. The shares set aside for grandchildren who survived Mrs.
Schutt were to be held as a single trust, from which net income
was to be distributed quarterly in equal shares to each
grandchild until the youngest such grandchild achieved the age of
40. Trust 2064 was to terminate on the earlier of (1) the date
the youngest grandchild living at Mrs. Schutt’s death reached 40,
(2) the death of all grandchildren living at Mrs. Schutt’s death,
or (3) the date 21 years after the death of the last survivor of
the issue of Mrs. Schutt’s grandfather, Alexis Irenee duPont,
living on October 6, 1934. Trust property remaining at
termination was to be distributed, if any such persons survived,
in equal shares to the income beneficiaries thereof.
As pertains to the administration of Trust 2064,
Mrs. Schutt’s will provided a representative listing of powers
granted to the trustee, subject to specified limitations. More
specifically, the will provided for an adviser of the trust (also
referred to herein as a “direction adviser”), and appointed
decedent as the initial direction adviser, a position he
continued to hold until his death. A committee made up of
Mrs. Schutt’s daughter-in-law Katherine Draper Schutt and son-in-
law Henry I. Brown III was designated to succeed decedent in this
role. Regarding the direction adviser, the will stated, in
relevant part:
I direct the trustee of each trust created in this
Will to exercise the powers granted to it * * *,
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relating to buying, selling, leasing, exchanging,
mortgaging, or pledging property held in such trust,
and participation in incorporations, reorganizations,
consolidations, liquidations, or mergers, only upon the
written direction of the advisor of such trust or of
the Committee, as the case may be.
* * * * * * *
Notwithstanding the previous provisions of this
Article, if at any time during the administration of
any trust hereunder, the advisor or Committee fail to
communicate in writing to Trustee any direction or
disapproval with respect to Trustee’s exercise of any
power requiring the direction of the advisor or
Committee within fifteen (15) days after trustee has
sent a written request for such direction to the
advisor’s or Committee members’ last known address by
registered or certified mail (but Trustee shall not be
required to take the initiative to seek any such
direction), then Trustee is authorized to take such
action in the matter as it, in its sole discretion,
deems appropriate.
The will further directed that the direction adviser and
Committee members exercise their functions in a fiduciary
capacity.
Trust 11258-3
As previously indicated, Mrs. Schutt’s death was also
significant with respect to the structure of a second trust
directly relevant to the factual background of this proceeding.
On January 16, 1976, Mrs. Schutt had established a revocable
trust, which was subsequently amended by supplemental trust
agreements dated April 9, 1976, June 6, 1979, December 30, 1982,
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and December 1, 1988.5 At Mrs. Schutt’s death, following payment
of certain cash bequests, the corpus of the revocable trust was
divided into three trusts: (1) A marital trust; (2) a
generation-skipping transfer tax exemption trust (GST trust); and
(3) a residuary trust. WTC became trustee of these trusts, the
GST portion of which is also referred to as Trust 11258-3.
The marital trust was to be funded with the “marital
deduction amount”, an amount which, taking into account
applicable provisions of the Code, resulted in a taxable estate
of $2.5 million, less the amount of any adjusted taxable gifts.
During decedent’s life, he was to receive net income therefrom
and so much of principal as he requested. At his death,
remaining corpus was to be distributed according to the exercise
of a power of appointment granted to decedent. In absence of an
exercise of this power, and after taking into account specified
provisions relating to payment of taxes and expenses, remaining
marital trust assets were to be added to the residuary trust.
The GST trust was to be funded with property equal in value
to the maximum amount then available to Mrs. Schutt under the
generation-skipping transfer tax exemption set forth in the Code.
The trustee was authorized, in its sole discretion, to distribute
5
One of the parties’ stipulations contains a mistaken
reference to the date of the final supplemental trust agreement
as Sept. 1, 1998. Elsewhere in the same stipulation, as well as
in the accompanying exhibit, the correct date of Dec. 1, 1988, is
reflected.
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net income and principal to Mrs. Schutt’s issue more remote than
children for their support, maintenance, education, care, and
welfare. The GST trust was to terminate 110 years after becoming
irrevocable, at which time the property was to be distributed
free of trust to Mrs. Schutt’s then-living issue, per stirpes.
The remaining assets of the revocable trust were to be
placed into the residuary trust. A share of the residuary trust
was set aside for each of Mrs. Schutt’s four children. Subject
to certain differences not material here, each child was given a
lifetime income interest in, and a limited testamentary power of
appointment over, his or her share. In default of any such
appointment by the child, the trustee was directed upon the
child’s death to distribute the assets free of trust to the
child’s then-living issue, per stirpes. Mrs. Schutt’s son,
Charles P. Schutt, Jr., was also authorized to withdraw up to
one-third of the value of his share upon request.
With respect to administration, the trust indenture provided
for powers to the trustee and a direction adviser or committee in
terms substantially identical to those contained in Trust 2064.
Mrs. Schutt was named as the initial direction adviser. She was
succeeded at her death in that role by decedent, a position he
held until his own death. Katherine Draper Schutt and Henry I.
Brown III were again named as the members of the committee to
succeed decedent.
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Revocable Trust
Like Mrs. Schutt, decedent on January 16, 1976, had
established a revocable trust, subsequently amended by
supplemental trust agreements dated April 9, 1976, June 6, 1979,
December 30, 1982, December 1, 1988, January 24, 1989, July 18,
1989, April 6, 1990, May 4, 1994, May 20, 1994, December 10,
1996, and May 21, 1997 (Revocable Trust). The Revocable Trust
was initially funded with life insurance policies on decedent’s
life and with various holdings in common stock. Decedent, Henry
I. Brown III, and Charles P. Schutt, Jr., were named as co-
trustees, positions they held until decedent’s death, at which
time Henry I. Brown III and Charles P. Schutt, Jr., continued as
successor co-trustees.
As amended, the trust agreement made the following
provisions with respect to distributions. During decedent’s
life, he was to receive all net income of the trust and so much
of the principal as he requested in writing at any time. At
decedent’s death, specified cash bequests were to be made to
named beneficiaries. Remaining corpus was to be divided into
three trusts: (1) A charitable lead trust; (2) a so-called
special trust; and (3) a residuary trust.
The charitable lead trust provided for a charitable lead
unitrust term beginning on the date of decedent’s death and
terminating 25 years thereafter, and for a unitrust amount to
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charity annually of 5 percent of the value of the trust assets.
The total value of the trust fund was to be an amount which would
produce a charitable deduction for the charitable lead trust
sufficiently large to leave a taxable estate equal to decedent’s
unused generation-skipping transfer tax exemption. At the
termination of the charitable interest, specified amounts were to
be distributed to grandchildren born after Mrs. Schutt’s death
and to then-living issue of any predeceased grandchild.
Assets not distributed under the just-described provisions
were to be held in trust and to be paid at the sole discretion of
the trustee for the support, maintenance, education, care, and
welfare of then-living grandchildren of decedent and then-living
issue of any grandchild dying prior to the termination of the
charitable lead. This trust was to terminate upon the earlier of
the death of decedent’s last-surviving grandchild or 110 years
after decedent’s death. At that time, the corpus was to be
distributed outright, per stirpes, to decedent’s then-living
great-grandchildren and to issue of any predeceased great-
grandchild.
The special trust was to be created by setting aside $2
million. Until the death of the last to die of decedent’s
children, income could be paid to any then-living child in the
discretion of the trustee, so long as the trustee was not a child
of decedent. Following the death of the last to die of
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decedent’s children, the trustee was to pay annually to the
University of Virginia an annuity equal to 4 percent of the value
of the special trust on the date of the last child’s death.
Throughout the trust’s term, principal could be used for the
full-time undergraduate college tuition of the issue of any of
decedent’s children. Unless earlier exhausted, the special trust
was to terminate 90 years after the death of the last grandchild
living at decedent’s death, at which time the corpus was to be
distributed free of trust to the University of Virginia.
The remaining assets of the revocable trust were to be
placed into the residuary trust. A share of the residuary trust
was to be set aside for each of decedent’s three living children
and the issue per stirpes of his predeceased daughter. Each
primary beneficiary was given a lifetime income interest in, and
a limited testamentary power of appointment over, his or her
share. In default of any such appointment, the trustee was
directed upon the beneficiary’s death to distribute the assets
free of trust to the beneficiary’s then-living issue, per
stirpes. Decedent’s son was also authorized to withdraw
principal not in excess of one-third of the value of his share
upon request.
Schutt Family Limited Partnership
In addition to the foregoing trusts, decedent and two of his
children, Charles P. Schutt, Jr., and Caroline Schutt Brown, on
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December 23, 1994, created the Schutt Family Limited Partnership.
On behalf of himself and the two children, decedent contributed
to the partnership Alabama timberlands,6 securities, and cash.
In return for these contributions (or deemed contributions), the
partners received units in the entity representing the following
interests:
Charles Porter Schutt: 5-percent general partnership interest
82.112-percent limited partnership interest
Charles P. Schutt, Jr.: 1-percent general partnership interest
5.444-percent limited partnership interest
Caroline Schutt Brown: 1-percent general partnership interest
5.444-percent limited partnership interest
Thereafter, decedent began making annual gifts of limited
partnership interests, apparently intended to qualify for the
exclusion under section 2503(b), to certain of his children,
their spouses, and their children.
Decedent’s Lifestyle and Health
At some time after his first wife’s death and prior to May
of 1994, decedent remarried, and he remained married to Greta
Brown Layton-Schutt at the time of his death. During the 1995
through 1998 period, decedent led an active lifestyle. This
6
Decedent had acquired interests in Alabama timberlands
with two of his brothers-in-law during the 1960s. Portions of
decedent’s interests in the timberlands and related operations
were placed in trust in 1971, see supra note 2, portions were
used in funding the Schutt Family Limited Partnership, and still
other portions continued to be owned outright by decedent at his
death.
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lifestyle included extensive traveling, boating, hunting, and
socializing, and decedent remained at his residence in
Wilmington, Delaware, only about 50 percent of the time. For
instance, during the 1995 through 1998 period, decedent made
regular visits to Vredenburgh, Alabama, to oversee both a working
farm he owned there and Schutt family timberlands in the
vicinity. He also traveled to, inter alia, England, Turkey,
China, Russia, and Africa, and he spent a substantial amount of
time cruising the Chesapeake Bay area on his yacht.
When at his home in Wilmington, decedent typically spent
mornings during the work week at the Carpenter/Schutt family
office7 reviewing investment literature, followed by lunch at the
Wilmington Club (a social club), followed by a return to the
family office for additional investment research. Decedent
subscribed to a buy and hold investment philosophy, as had his
father-in-law, Mr. duPont.
This philosophy emphasized the acquisition of stock in
quality companies that would provide both income and value
appreciation, which would then be held for the long term. In
particular, decedent, like Mr. duPont before him, stressed
maintaining the family’s large holdings in DuPont and, depending
7
Mrs. Carpenter and Mrs. Schutt were both daughters of
Mr. duPont. Since at least the early 1970s, the two families had
maintained a joint family office with staff overseeing and
assisting in business and personal matters for family members.
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on the time frame and absent drastic circumstances, Phillips or
Exxon. Over the years, decedent also on numerous occasions
expressed concern about family members selling DuPont or Exxon
shares, and he was displeased with such sales made by
grandchildren during the 1990s.
During the 1996 through 1998 period, decedent was under the
regular care of his family physician and a cardiologist in
Wilmington, Delaware, and of another family physician in Camden,
Alabama. Decedent’s health history during the period included
coronary artery disease, congestive heart failure,
hyperlipidemia, hypertension, renal insufficiency, and gout. On
November 29, 1996, decedent was admitted to the hospital
complaining of shortness of breath. He was released on December
5, 1996, after receipt of fluids, monitoring, and adjustment of
his medication. He was also admitted briefly to a hospital in
Camden, Alabama, on January 6, 1998, because of similar medical
problems.
Schutt I and II
During late 1996 or early 1997, decedent and two of his
principal advisers, Stephen J. Dinneen and Thomas P. Sweeney,
began discussions concerning the transfer of assets out of the
Revocable Trust to another investment vehicle. Mr. Dinneen was a
certified public accountant who was in charge of accounting and
tax work and served as the office manager for the
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Carpenter/Schutt family office. Among other things, he advised
Schutt family members on investment and business matters and had
been employed by the family since 1973. Mr. Sweeney, a member of
the law firm Richards, Layton & Finger, P.A., during this period
served as decedent’s attorney on tax and estate planning matters.
Decedent had been a client of Mr. Sweeney since 1967.
Among the considerations providing an impetus for this
potential restructuring of decedent’s assets, Mr. Sweeney and/or
Mr. Dinneen recall discussing: (1) Decedent’s concerns regarding
sales by family members of core stockholdings and his desire to
extend and perpetuate his buy and hold investment philosophy over
family assets; (2) the need to develop another vehicle through
which decedent could continue to make annual exclusion gifts due
to exhaustion of available units in the family limited
partnership for this purpose; and (3) the possibility of
valuation discounts. Following the initial discussions with
decedent, Mr. Sweeney and Mr. Dinneen undertook to investigate
possible alternative entity structures for decedent’s assets.
Over the course of the next 15 months, a process of meetings,
discussions, and research, extensively documented in letters,
memoranda, and notes, took place and culminated in the formation
of Schutt I and II on March 17, 1998.
On January 27, 1997, Mr. Sweeney sent to Mr. Dinneen a
letter enclosing a memorandum entitled “CONSIDERATIONS RELEVANT
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IN CHOOSING BETWEEN A FAMILY LIMITED PARTNERSHIP, A LIMITED
LIABILITY COMPANY, AND A DELAWARE BUSINESS TRUST”.8 The
memorandum first summarized characteristics, benefits, and
problems associated with each entity, including potential
transfer tax savings and the problem of being classified as an
“investment company” within the meaning of section 721(b). The
second half of the memorandum was then devoted to a more extended
discussion of valuation discounts for estate planning purposes.
In the cover letter, Mr. Sweeney recommended use of “a Delaware
business trust because this would avoid the implications of an
investment company since what is to be transferred is a
diversified portfolio of marketable securities being transferred
by one person.” He also expressed general observations regarding
the types of discounts that could be available “If Porter died
owning a substantial portion of the interest” in the entity and
noted the need for a qualified appraiser to determine the precise
amount of the discount.
On February 3, 1997, Mr. Sweeney met with decedent and
Mr. Dinneen to further discuss entity formation issues raised in
the January 27 letter. Upon reviewing the memorandum, Mr.
8
During the 1997 to early 1998 period, a Delaware business
trust was formed pursuant to the Delaware Business Trust Act,
Del. Code Ann. tit. 12, secs. 3801-3822 (Supp. 2004). Effective
September 1, 2002, the Delaware Business Trust Act was replaced
by the Delaware Statutory Trust Act, Del. Code Ann. tit. 12,
secs. 3801-3826 (Supp. 2004).
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Dinneen had come up with the idea of creating a Delaware business
trust in which decedent held a minority interest and served as
trustee, while the remaining interests would be held for the
benefit of his children and grandchildren by WTC trusts of which
decedent was the direction or consent adviser. The participants
agreed to pursue this idea, and decedent authorized Mr. Sweeney
to contact representatives of WTC to discuss the joint creation
of a business trust. They also reviewed at the meeting a
computation prepared by Mr. Dinneen reflecting the estimated
difference in Federal estate tax and net inherited amount under
decedent’s current estate plan and under a plan where a portion
of his assets would be placed into an entity subject to minority
and marketability discounts.
In early February 1997, on decedent’s behalf, Mr. Sweeney
met with representatives of WTC to determine whether the company
would consider being involved with decedent in forming a Delaware
business trust and, if so, under what conditions. Specifically,
on February 5, 1997, Mr. Sweeney met with George W. Helme IV,
senior vice president and head of the trust department of WTC.
Mr. Helme indicated that, in concept, the company was willing to
participate, and he directed Mr. Sweeney to speak with the legal
staff of the trust department regarding details. Mr. Sweeney
reported these developments to decedent in a letter dated
February 6, 1997.
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On February 10, 1997, Mr. Sweeney sent a memorandum to
Kathleen E. Lee, another attorney at his firm, asking her to
research certain issues with respect to the potential business
trust transaction. He also summarized therein as follows:
The present concept that is being considered is
that Porter would put up $40 million of his portfolio,
and between trusts 2064 and 3044-5, 3044-6 and 3044-8,
the Wilmington Trust Company would put up approximately
$42 million. The net effect would be that Porter’s
funded revocable trust would then have a minority
interest in the business trust, and possibly at
Porter’s death, we could obtain both lack of
marketability and minority interest discounts with
respect to Porter’s interest in the Delaware business
trust.
He further noted: “it is anticipated that Porter Schutt will at
some time in the not too distant future after the transaction is
implemented commence to give away to his children in the form of
taxable gifts interests in the Delaware business trust.”
Ms. Lee responded to the following four questions by
memorandum dated March 5, 1997:
1. If our client and the Wilmington Trust
Company contribute investment portfolios consisting of
marketable securities into a Delaware Business Trust,
would such contributions give rise to investment
company status under § 721(b) of the Internal Revenue
Code of 1986, as amended (the “Code”) such that a
realization of gain must be recognized upon the
creation of the Delaware Business Trust?
2. Can the Delaware Business Trust make an
election under § 754 of the Code to increase basis in
the underlying assets of the Delaware Business Trust?
3. How should the Delaware Business Trust be
structured so that the entity will continue after the
death of our client?
-22-
4. What valuation discounts should be given for
a minority interest and a lack of marketability in a
Delaware Business Trust which consists solely of a
portfolio of marketable securities?
During the period March through August 1997, Mr. Sweeney
continued discussions with WTC concerning the formation of a
Delaware business trust to hold certain of the assets of the WTC
trusts and the Revocable Trust. These discussions began with a
meeting that took place on March 4, 1997, between Cynthia L.
Corliss, Mary B. Hickok, and Neal J. Howard, who attended the
meeting on behalf of the trust department legal staff of WTC, and
Mr. Sweeney. Subsequent to this meeting, Mr. Sweeney received a
memorandum from Ms. Corliss, Ms. Hickok, and Mr. Howard, dated
March 6, 1997, stating initial concerns of WTC regarding use of a
business trust. Specifically, the memorandum expressed desire on
the part of WTC: (1) To ensure that none of the WTC trusts would
be subjected to tax on built-in capital gains attributable to
sales of assets contributed by the Revocable Trust or any other
WTC trust; (2) to structure the business trust so that WTC and
decedent remained in the same relative positions as then enjoyed
with respect to control over investment decisions; (3) to obtain
consents from existing beneficiaries of the WTC trusts agreeing
to formation of the business trust; and (4) to have all assets of
the business trust held in a WTC custody account.
Thereafter, Mr. Sweeney and attorneys at his firm undertook
to research and address the concerns raised by WTC. For
-23-
instance, at Mr. Sweeney’s direction, Cynthia D. Kaiser analyzed
potential securities law issues attendant to the proposed
transaction and Julian H. Baumann, Jr., researched partnership
income tax matters broached in WTC’s March 6, 1997, memorandum.
In addition, discussions and negotiations between Mr. Sweeney and
WTC representatives, in which Mr. Howard took the lead role on
behalf of WTC, continued in the form of letters, telephone
conversations, and other meetings. Mr. Sweeney and Mr. Dinneen
also communicated regularly about issues that arose, as phrased
in one letter, “in connection with our pursuing the Delaware
business trust for Porter and his family in order to make certain
that those entities with respect to which Porter has investment
responsibility are being managed in a consistent manner.”
Decedent was likewise kept informed regarding the status of the
discussions and negotiations. For example, a letter to decedent
from Mr. Sweeney, dated July 14, 1997, explained as follows:
I apologize for the delay in getting to you this
letter which outlines the structure for a Delaware
business trust. There are still a number of issues
which need to be addressed and worked through with the
Wilmington Trust Company, and we will proceed to have
further discussions with them in this regard.
The purpose of the Delaware business trust would
be to have under one document all of the trust assets
of which you are either the direction or consent
investment advisor, including a substantial portion of
your own portfolio presently held in your funded
revocable trust. In this manner, there could be a
consistent investment policy with respect to the assets
in which the Schutt family has an equitable interest
-24-
and thus provide a vehicle through which a more
coordinated investment policy can be administered.
The first major issue which needs to be addressed
and with respect to which hopefully Steve Dinneen can
provide the detailed information from the Wilmington
Trust Company reports from the various trusts is to
make certain that going into a Delaware business trust
does not create a taxable transaction. The critical
thing is to make certain that the creation of the
business trust does not constitute “an investment
company” in the context of the pertinent provisions of
the Internal Revenue Code. * * *
* * * * * * *
Structurally, it would be proposed that you be
named as the initial trustee of the Delaware business
trust with perhaps the Wilmington Trust Company being
the successor trustee, and that the business trust have
perpetual existence which would not be terminated or
revoked by a beneficial owner or other person except in
accordance with the terms of its governing instrument.
In addition, it should provide that death, incapacity,
dissolution, termination or bankruptcy of a beneficial
owner will not result in the termination or dissolution
of the business trust except to the extent as otherwise
provided in the governing instrument of the business
trust.
We would propose that investment decisions would
be those recommended by you, subject to review by the
Wilmington Trust Company, and that your view would
control based on the terms of the various trusts which
would become participants.
In the event of termination of one of the trusts
investing in the Delaware business trust occurs, then
the assets which would be distributed to the persons
entitled to the beneficial [sic] would be interests in
the Delaware business trust which would continue in
existence as noted above.
The issue raised in the March 6 Wilmington Trust
Company memo pertaining to separate sections of the
Delaware business trust so that certain trusts are not
subject to a share of the capital gains generated by
other sales is of concern because it appears that that
-25-
would be inconsistent with the normal treatment of
investment partnerships for tax purposes. * * *
In addition to the foregoing, we have examined
certain federal and Delaware security law aspects of
creating such a business trust. There may be both
state and federal filing requirements to consider.
However, these requirements will be somewhat limited if
it can be illustrated that each investor is a “credited
investor,” * * *
* * * * * * *
Once we are certain that you are in agreement with
structuring the business trust as generally indicated
above, then we will go back to the Wilmington Trust
Company and try to work out with them in more detail
the issues they have raised and the proposed solutions
in connection therewith.
On August 27, 1997, Mr. Sweeney met with Mr. Dinneen and
decedent to review whether, given the preliminary work completed
to date, decedent was willing to proceed with the transaction.
Decedent indicated a willingness to do so, but during the
meeting, several points were emphasized: (1) The trust should be
structured so as to avoid the “investment company problem”; (2)
decedent wished to be the trustee, with his son, son-in-law, and
perhaps even their wives as successor trustees; (3) decedent
wanted to ensure that fees to be received by WTC for serving as
both trustee of the WTC trusts and custodian of the business
trust assets would not result in “double dipping” and thereby
exceed fees currently being charged; (4) the trust arrangement
should be such that only precontribution gain, and not
postcontribution gain, was allocated solely to the contributing
-26-
trust; and (5) decedent desired to retain final say on investment
decisions, although WTC could be permitted some involvement.
Shortly thereafter, on September 4, 1997, Mr. Sweeney met
with Mr. Howard and Ms. Hickok of WTC. The following issues were
among those addressed at this conference. (1) With respect to
the burden of capital gains tax on future asset sales, Mr. Howard
and Ms. Hickok clarified that the concern previously raised
focused on precontribution gain, and they agreed that operative
partnership tax rules under section 704 resolved their concerns.
(2) In connection with fulfilling fiduciary duties, Mr. Howard
and Ms. Hickok indicated a desire to obtain consents from
beneficiaries of various WTC trusts participating in the business
trust transaction. (3) As to the investment company issue, the
participants discussed the stock concentrations within the
relevant portfolios and broached as a topic for further research
whether contributing only DuPont stock to the business trust
could avoid the problem. (4) Regarding the length of the trust’s
existence, the WTC representatives expressed interest in a 30- to
40-year term, while Mr. Sweeney suggested at least a 40- to 50-
year term. (5) On the matter of investment decisions, Mr.
Sweeney stressed that decedent wanted the trust structured so
that he would have the final vote and control, to which Mr.
Howard and Ms. Hickok ultimately agreed so long as WTC had some
input. (6) Lastly, as to WTC’s fees, Mr. Howard and Ms. Hickok
-27-
agreed that with respect to assets contributed by the WTC trusts,
the combined custodian and trustee fees would not exceed current
charges. However, they indicated that “new” fees would be
charged for custody of stock contributed by decedent’s Revocable
Trust. Mr. Sweeney indicated that this issue would have to be
analyzed further and negotiated.
Mr. Sweeney reported the foregoing to decedent in a letter
dated September 5, 1997, and also on that date requested that
Ms. Lee research certain of the issues raised. On September 22,
1997, Mr. Sweeney sent a further letter to decedent indicating
that contribution of only DuPont stock to the business trust
appeared, based on the research performed, to avoid the
investment company problem. Mr. Sweeney asked decedent to
consider whether proceeding on that basis would accomplish his
objectives.
During late 1997, discussions continued between Mr. Sweeney
and WTC representatives, with Mr. Sweeney making several
proposals to address WTC concerns. In particular, following
analysis by Mr. Dinneen of holdings of the various trusts,
Mr. Sweeney proposed that, in order to avoid characterization as
an investment company for income tax purposes under section
721(b), two separate business trusts be created. One would hold
exclusively DuPont stock, and the other would hold only Exxon
shares.
-28-
WTC, in a November 26, 1997, letter to Mr. Sweeney,
ultimately agreed to structure the transactions as Mr. Sweeney
proposed, subject to enumerated conditions: (1) WTC would have
the opportunity to review the business trusts to ensure they were
in a form satisfactory for WTC to proceed; (2) all adult
beneficiaries of the WTC trusts would execute a consent form, to
which a copy of the business trusts would be attached, “whereby
they acknowledge and consent to the trusts’ investing in the
business trusts and that they recognize that the business trusts
may last beyond the termination date of the trusts of which they
are a beneficiary”; and (3) business trust assets would be placed
in custody with WTC, with fees charged as set forth in an
attached November 25, 1997, proposal.
Mr. Sweeney communicated these conditions to decedent, and
negotiations continued with respect to the fee arrangement. For
instance, decedent requested that the proposed fee agreement be
amended: (1) To provide clearly that WTC’s commissions as
custodian of the business trust assets would not exceed the fees
lost on trustee fees from the participating trusts, and (2) to
address the ability of the trustee of the business trusts to
change the custodian if WTC were to be acquired by another bank.
WTC agreed to make changes addressing these concerns.
Also during December of 1997, drafts of the business trusts
were prepared and circulated for comment amongst decedent, his
-29-
advisers, and WTC. Mr. Sweeney had initially asked Ms. Lee to
begin drafting the documents in a November 14, 1997, memorandum
that set forth details regarding certain provisions to be
included. Regarding purpose, the memorandum stated:
You will recall that the purpose of the two
Delaware business trusts is to preserve and coordinate
Porter Schutt’s investment philosophy with respect to
those trusts over which he has either direction or
consent investment advice of which the Wilmington Trust
Company is trustee, as well as his own funded revocable
trust. Over the years, Porter Schutt has developed a
buy and hold philosophy which has been quite
successful, and he is anxious to have that philosophy
preserved for his family for the future.
In a January 6, 1998, telephone conversation, Mr. Howard
pointed out, along with several minor drafting errors, what he
considered to be a significant substantive problem with the
provision then included in the trust documents regarding
distributions. The initial drafts of the trust stated that net
cashflow would be distributed at such times and in such amounts
as determined by the trustee in his discretion. WTC wanted the
trusts to provide for distribution of net cashflow at least
annually. Mr. Sweeney thought that quarterly distributions could
accord with decedent’s original intent, and the documents were
revised to so provide, for further review by the participants.
By a letter dated January 9, 1998, WTC confirmed its
agreement with the form and content of the Schutt I and Schutt II
indentures, and work proceeded to prepare and finalize the
beneficiary consent documents. Like the trusts, the consents
-30-
were circulated for comment and revision. Mr. Sweeney sent a
draft consent to decedent on January 23, 1998, under a cover
letter summarizing the rationale for certain provisions, e.g.,
we have included a recital to the effect that you will
be contributing DuPont and Exxon stock out of your
trust to the respective Business Trusts which clarifies
that this is really a family matter and a method of
preserving the investment philosophy you have developed
which has been so successful for the family.
Mr. Howard subsequently suggested on behalf of WTC that the
consents indicate the percentage of the participating trust’s
assets being contributed to the business trusts so that the
beneficiaries would have a clearer understanding of the impact of
the investments on their beneficial interests. Decedent agreed
to this modification.
The finalized consent forms, accompanied by copies of the
business trust agreements, were circulated to the beneficiaries
for signature on February 12, 1998. The forms provided that the
beneficiaries consented to the contribution of certain securities
to the business trusts and released WTC and decedent “from any
and all action, suits, claims, accounts, and demands * * * for or
on account of any matter or thing made, done, or permitted by the
Advisor or the Trustees in connection with the contribution of
securities to the Business Trusts.” All living beneficiaries of
Trusts 2064, 3044-1, 3044-2, 3044-5, 3044-6, 3044-8, and 11253-3
executed the consent and release forms in February and early
March of 1998.
-31-
The trust agreements for Schutt I and Schutt II were signed
on March 11, 1998, by WTC as trustee for Trusts 2064, 3044-1,
3044-2, 3044-5, 3044-6, 3044-8, and 11258-3 and were signed on
March 17, 1998, by decedent, Charles P. Schutt, Jr., and Henry I.
Brown III as trustees of the Revocable Trust. On or about March
30, 1998, a Form SS-4, Application for Employer Identification
Number, was signed and thereafter filed with the Internal Revenue
Service for each business trust. Similarly, on April 1, 1998, a
Certificate of Business Trust Registration for each Schutt I and
Schutt II was filed with the Office of the Secretary of State for
the State of Delaware.
Funding of the business trusts began in March of 1998 and
establishment of a WTC account for each business trust, with the
account for Schutt I holding the DuPont securities and the
account for Schutt II holding the Exxon securities, was completed
at least by mid-April. The custody agreements for the business
trusts were executed by decedent and a representative of WTC on
April 1, 1998. As a result of the funding, the following capital
contributions were made, and proportionate percentage interests
received, in Schutt I and Schutt II:
-32-
SCHUTT I
Unit DuPont Monetary Percentage
Holder Shares Value Interest
Revocable Trust 472,200 $30,752,025.00 45.236
Trust 2064 108,000 7,033,500.00 10.346
Trust 3044-1 19,098 1,243,757.25 1.830
Trust 3044-2 23,670 1,541,508.75 2.268
Trust 3044-5 132,962 8,659,150.25 12.738
Trust 3044-6 132,962 8,659,150.25 12.738
Trust 3044-8 132,960 8,659,020.00 12.737
Trust 11258-3 22,000 1,432,750.00 2.108
Totals 1,043,852 67,980,861.50 100
(rounded)
SCHUTT II
Unit Exxon Monetary Percentage
Holder Shares Value Interest
Revocable Trust 178,200 $11,237,737.50 47.336
Trust 2064 156,000 9,837,750.00 41.439
Trust 3044-5 11,418 720,047.63 3.033
Trust 3044-6 11,418 720,047.63 3.033
Trust 3044-8 11,418 720,047.63 3.033
Trust 11258-3 8,000 504,500.00 2.125
Totals 376,454 23,740,130.39 100
(rounded)
The values of the shares and resultant percentage interests were
calculated based on the average of the high and low prices for
the stock on March 17, 1998, the effective date of the business
trust agreements.
At the time Schutt I and Schutt II were formed, decedent
owned assets not contributed to the business trusts with a fair
market value of approximately $30,000,000. These assets
included, without limitation, marketable securities, Alabama
-33-
timberland, cattle, investments in partnerships, a one-third
undivided interest in South Carolina real estate, residential
real estate located in Delaware and Alabama, and tangible
personal property.
The trust agreements for Schutt I and Schutt II entered into
as of March 17, 1998, were substantially identical and set forth
the governing provisions for the entities. The agreements
recited an intent to create a Delaware business trust, to be
classified as a partnership for Federal income tax purposes. The
stated purpose of the trusts was
to engage in any lawful act or activity for which
business trusts may be formed under the Act [Delaware
Business Trust Act, Del. Code Ann. tit. 12, secs. 3801-
3822], including the ownership and operation of every
type of property and business, and the Trust may
perform all acts necessary or incidental to the
furtherance of such purpose.
The trust agreements were to be governed by and interpreted in
accordance with the laws of the State of Delaware.
Decedent was named as the initial trustee, with his term to
continue until his death, resignation, or adjudged incompetence.
Charles P. Schutt, Jr., Henry I. Brown III, and Caroline S.
Brown, in that order, were designated successor trustees. If
none of the named successor trustees was able or willing to
serve, an individual resident in the State of Delaware was to be
selected by the vote of unit holders holding at least 66 percent
of the interests in the trust.
-34-
As regards powers of the trustee, the agreements provided
generally:
Subject to the express limitations herein, the business
and affairs of the Trust shall be managed by or under
the direction of the Trustee, who shall have full,
exclusive and absolute power, control and authority
over the Property and over the business of the Trust.
The Trustee may take any actions as in his or her sole
judgment and discretion are necessary or desirable to
conduct the business of the Trust. This Agreement
shall be construed with a presumption in favor of the
grant of power and authority to the Trustee. * * *
The agreements then enumerated specific powers, such as the
ability to invest, transfer, dispose of, lend, and exercise
voting and other ownership rights of trust property. The trustee
was also expressly authorized to establish or change policies to
govern the investment of trust assets.
Concerning capital contributions and accounts, the
agreements stated that a capital account was to be maintained for
each unit holder by crediting thereto the unit holder’s capital
contributions, distributive share of profits, and amount of any
trust liabilities assumed, and by debiting the value of cash or
other property distributed to the unit holder, the unit holder’s
distributive share of losses, and the amount of unit holder
liabilities assumed by the trust. Profits and losses were
generally to be allocated in proportion to the unit holders’
interests in the entity, and allocations for tax purposes with
respect to contributed property were to be made in accordance
with section 704(c). Any return of a capital contribution, in
-35-
whole or in part, could be made only upon the consent of a
majority in interest of the unit holders.
With respect to distributions, the trust agreements
specified that “Net Cash Flow shall be distributed by the Trustee
on or before the last day of each calendar quarter”. “Net Cash
Flow” was defined as gross cash receipts, less amounts paid by or
for the account of the trust, less “any amounts determined by the
Trustee, in his discretion, to be necessary to provide a
reasonable reserve for working-capital needs or to provide funds
for any other contingencies of the Trust.” The distributions
were to be made in accordance with the proportionate interests of
the unit holders in the entity.
The agreements prohibited the sale, transfer, assignment,
pledge, encumbrance, mortgage, or other hypothecation of any unit
holder’s interest, as well as withdrawal by a unit holder from
the trust, without the consent of all unit holders. The stated
term of the trusts was to extend until December 31, 2048, but the
agreements provided that the term could be extended beyond that
date with the written approval before December 31, 2048, of both
the trustee and a majority in interest of the unit holders, or
the trusts could be dissolved prior to that date upon the written
consent of all unit holders. Upon dissolution and termination,
the trusts were to be liquidated. Proceeds of the liquidation
were to be disposed of first in payment to creditors of the
-36-
trusts, then for the establishment of any additional reserves
deemed by the trustee to be reasonably necessary for any
contingent liabilities, and then to unit holders in accordance
with their capital account balances.
Regarding amendments, the trust agreements provided as a
general rule that any amendment must be in writing and approved
by holders of at least an aggregate 66-percent interest in the
entity. Two modifications of this rule were likewise set forth.
First, the trustee was authorized to amend the agreements without
any unit holder’s consent to (1) correct any patent error,
omission, or ambiguity, and (2) add or delete any provision as
necessary to attain and maintain qualification as a partnership
for Federal income tax purposes or to comply with any Federal or
State securities law, regulation, or other requirement. The
second modification required the written consent of all unit
holders to convert the trust to a general partnership or to
change the liability of or reduce the interests in capital,
profits, or losses of the unit holders. On a related point, the
trust agreements specifically mandated 66 percent approval for
transfer of any part of the trust corpus to another business
trust, partnership, or corporation in exchange for an ownership
interest in the entity and for merger or consolidation of the
trust with another business entity.
-37-
Since the formation and funding of Schutt I and II, the net
cashflow of each trust has been distributed pro rata on a
quarterly basis, as required by the trust documents. The trusts
have also filed annual Federal income tax returns reporting,
inter alia, the pro rata distributive shares of income, credits,
deductions, etc., allocated to each unit holder. Through at
least the time of decedent’s death, the trusts had never sold any
of the DuPont or Exxon shares used to fund the entities, nor had
they acquired any other assets.9 Decedent’s personal assets were
not commingled with those of Schutt I or Schutt II.
Estate Tax Proceedings
As previously stated, decedent died on April 21, 1999,
approximately 1 year after Schutt I and II were formed. A Form
706, United States Estate (and Generation-Skipping Transfer) Tax
Return, was filed on behalf of decedent on or about January 21,
2000. An election was made therein to use the alternate
valuation date of October 21, 1999. The value reported for the
gross estate on the Form 706 was $61,590,355.08, which included
$15,837,295.45 and $7,237,104.56 for the Revocable Trust’s
interests in Schutt I and Schutt II, respectively. As of October
9
At trial, on direct examination, Mr. Dineen was asked:
“And have either Schutt I or Schutt II sold DuPont stock?” He
responded: “No.” Although not free from ambiguity given that
Schutt II held only Exxon stock, a reasonable inference from this
testimony would appear to be that neither business trust had sold
assets through the time of trial.
-38-
21, 1999, the underlying asset value of Schutt I was $65,273,495,
of which the Revocable Trust’s proportionate share was
$29,527,314. The underlying asset value of Schutt II was
$28,504,626, of which the Revocable Trust’s proportionate share
was $13,493,064.
In the notice of deficiency issued on October 11, 2002,
respondent determined that the discounts applied in valuing the
interests in Schutt I and Schutt II were excessive. The estate
timely filed the instant proceeding challenging the statutory
notice. By amendment to answer filed in this case, respondent
then asserted an increased deficiency on the grounds that the
full fair market value of the underlying assets contributed by
the Revocable Trust to Schutt I and Schutt II should be included
in decedent’s gross estate under sections 2036(a) and 2038. The
parties have since stipulated that if the Court rejects
respondent’s position under sections 2036 and 2038, they agree
that the Schutt I and II units held by the Revocable Trust should
be included in decedent’s gross estate at the respective values
of $19,930,937 and $9,107,818.
OPINION
I. Inclusion in the Gross Estate--Sections 2036 and 2038
A. General Rules
As a general rule, the Code imposes a Federal excise tax “on
the transfer of the taxable estate of every decedent who is a
-39-
citizen or resident of the United States.” Sec. 2001(a). The
taxable estate, in turn, is defined as “the value of the gross
estate”, less applicable deductions. Sec. 2051. Section 2031(a)
specifies that the gross estate comprises “all property, real or
personal, tangible or intangible, wherever situated”, to the
extent provided in sections 2033 through 2045 (i.e., subtitle B,
chapter 11, subchapter A, part III of the Code).
Section 2033 states broadly that “The value of the gross
estate shall include the value of all property to the extent of
the interest therein of the decedent at the time of his death.”
Sections 2034 through 2045 then explicitly mandate inclusion of
several more narrowly defined classes of assets. Among these
specific sections is section 2036, which reads in pertinent part
as follows:
SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.
(a) General Rule.--The value of the gross estate
shall include the value of all property to the extent
of any interest therein of which the decedent has at
any time made a transfer (except in case of a bona fide
sale for an adequate and full consideration in money or
money’s worth), by trust or otherwise, under which he
has retained for his life or for any period not
ascertainable without reference to his death or for any
period which does not in fact end before his death--
(1) the possession or enjoyment of, or the
right to the income from, the property, or
(2) the right, either alone or in conjunction
with any person, to designate the persons who
shall possess or enjoy the property or the income
therefrom.
-40-
Regulations further explain that “An interest or right is treated
as having been retained or reserved if at the time of the
transfer there was an understanding, express or implied, that the
interest or right would later be conferred.” Sec. 20.2036-1(a),
Estate Tax Regs.
Given the language used in the above-quoted provisions, it
has long been recognized that “The general purpose of this
section is ‘to include in a decedent’s gross estate transfers
that are essentially testamentary’ in nature.” Ray v. United
States, 762 F.2d 1361, 1362 (9th Cir. 1985) (quoting United
States v. Estate of Grace,
395 U.S. 316, 320 (1969)). The
Supreme Court has defined as “essentially testamentary” those
“transfers which leave the transferor a significant interest in
or control over the property transferred during his lifetime.”
United States v. Estate of Grace, supra at 320. Accordingly,
courts have emphasized that the statute “describes a broad scheme
of inclusion in the gross estate, not limited by the form of the
transaction, but concerned with all inter vivos transfers where
outright disposition of the property is delayed until the
transferor’s death.” Guynn v. United States,
437 F.2d 1148, 1150
(4th Cir. 1971).
As used in section 2036(a)(1), the term “enjoyment” has been
described as “synonymous with substantial present economic
benefit.” Estate of McNichol v. Commissioner, 265 F.2d 667, 671
-41-
(3d Cir. 1959), affg. 29 T.C. 1179 (1958); see also Estate of
Reichardt v. Commissioner,
114 T.C. 144, 151 (2000). Regulations
additionally provide that use, possession, right to income, or
other enjoyment of transferred property is considered as having
been retained or reserved “to the extent that the use,
possession, right to the income, or other enjoyment is to be
applied toward the discharge of a legal obligation of the
decedent, or otherwise for his pecuniary benefit.” Sec. 20.2036-
1(b)(2), Estate Tax Regs. Moreover, possession or enjoyment of
transferred property is retained for purposes of section
2036(a)(1) where there is an express or implied understanding to
that effect among the parties at the time of the transfer, even
if the retained interest is not legally enforceable. Estate of
Maxwell v. Commissioner,
3 F.3d 591, 593 (2d Cir. 1993), affg.
98
T.C. 594 (1992); Guynn v. United States, supra at 1150; Estate of
Reichardt v.
Commissioner, supra at 151; Estate of Rapelje v.
Commissioner,
73 T.C. 82, 86 (1979). The existence or
nonexistence of such an understanding is determined from all of
the facts and circumstances surrounding both the transfer itself
and the subsequent use of the property. Estate of Reichardt v.
Commissioner, supra at 151; Estate of Rapelje v.
Commissioner,
supra at 86.
As used in section 2036(a)(2), the term “right” has been
construed to “connote[] an ascertainable and legally enforceable
-42-
power”. United States v. Byrum, 408 U.S. 125, 136 (1972).
Nonetheless, regulations clarify:
With respect to such a power, it is immaterial
(i) whether the power was exercisable alone or only in
conjunction with another person or persons, whether or
not having an adverse interest; (ii) in what capacity
the power was exercisable by the decedent or by another
person or persons in conjunction with the decedent; and
(iii) whether the exercise of the power was subject to
a contingency beyond the decedent’s control which did
not occur before his death (e.g., the death of another
person during the decedent’s lifetime). The phrase,
however, does not include a power over the transferred
property itself which does not affect the enjoyment of
the income received or earned during the decedent’s
life. * * * Nor does the phrase apply to a power held
solely by a person other than the decedent. But, for
example, if the decedent reserved the unrestricted
power to remove or discharge a trustee at any time and
appoint himself as trustee, the decedent is considered
as having the powers of the trustee. [Sec. 20.2036-
1(b)(3), Estate Tax Regs.]
Additionally, retention of a right to exercise managerial power
over transferred assets or investments does not in and of itself
result in inclusion under section 2036(a)(2). United States v.
Byrum, supra at 132-134.
An exception to the treatment mandated by section 2036(a)
exists where the facts establish “a bona fide sale for an
adequate and full consideration in money or money’s worth”.
Like section 2036, section 2038 provides for inclusion in
the gross estate of the value of transferred property.
Specifically, as pertinent here, section 2038(a)(1) addresses
revocable transfers and requires inclusion of the value of
property:
-43-
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, where the enjoyment thereof was subject at
the date of his death to any change through the
exercise of a power (in whatever capacity exercisable)
by the decedent alone or by the decedent in conjunction
with any other person (without regard to when or from
what source the decedent acquired such power), to
alter, amend, revoke, or terminate, or where any such
power is relinquished during the 3-year period ending
on the date of the decedent’s death.
Regulations promulgated under the statute clarify that section
2038 does not apply:
(1) To the extent that the transfer was for an
adequate and full consideration in money or money’s
worth (see § 20.2043-1);
(2) If the decedent’s power could be exercised
only with the consent of all parties having an interest
(vested or contingent) in the transferred property, and
if the power adds nothing to the rights of the parties
under local law; or
(3) To a power held solely by a person other than
the decedent. * * * [Sec. 20-2038-1(a), Estate Tax
Regs.]
B. Burden of Proof
Typically, the burden of disproving the existence of an
agreement regarding a retained interest has rested on the estate,
and this burden has often been characterized as particularly
onerous in intrafamily situations. Estate of Maxwell v.
Commissioner, supra at 594; Estate of Reichardt v.
Commissioner,
supra at 151-152; Estate of Rapelje v.
Commissioner, supra at 86.
In this case, however, the section 2036 and 2038 issues were not
-44-
raised in the statutory notice of deficiency and are therefore
new matters within the meaning of Rule 142(a). Thus, as
respondent has conceded, the burden of proof is on respondent.
C. The Parenthetical Exception
Sections 2036 and 2038 each contain an identical
parenthetical exception for “a bona fide sale for an adequate and
full consideration in money or money’s worth”. Regulations
promulgated under both sections reference the definition for this
phrase contained in section 20.2043-1, Estate Tax Regs. Secs.
20.2036-1(a), 20.2038-1(a)(1), Estate Tax Regs. Section 20.2043-
1(a), Estate Tax Regs., provides: “To constitute a bona fide
sale for an adequate and full consideration in money or money’s
worth, the transfer must have been made in good faith, and the
price must have been an adequate and full equivalent reducible to
a money value.”
Availability of the exception thus rests on two
requirements: (1) A bona fide sale and (2) adequate and full
consideration. This Court has recently summarized when these
requirements will be satisfied, as follows:
In the context of family limited partnerships, the
bona fide sale for adequate and full consideration
exception is met where the record establishes the
existence of a legitimate and significant nontax reason
for creating the family limited partnership, and the
transferors received partnership interests
proportionate to the value of the property transferred.
* * * The objective evidence must indicate that the
nontax reason was a significant factor that motivated
-45-
the partnership’s creation. * * * [Estate of Bongard v.
Commissioner, 124 T.C. __, __ (2005) (slip op. at 39).]
Bona Fide Sale
The Court of Appeals for the Third Circuit, to which appeal
in this case would normally lie, has emphasized that the bona
fide sale prong will only be met where the transfer was made in
good faith. Estate of Thompson v. Commissioner, 382 F.3d 367,
383 (3d Cir. 2004) (citing sec. 20.2043-1(a), Estate Tax Regs.),
affg. T.C. Memo. 2002-246. In the context of family entities,
the Court of Appeals set forth the following test: “A ‘good
faith’ transfer to a family limited partnership must provide the
transferor some potential for benefit other than the potential
estate tax advantages that might result from holding assets in
the partnership form.”
Id. Stated otherwise, “if there is no
discernable purpose or benefit for the transfer other than estate
tax savings, the sale is not ‘bona fide’ within the meaning of
§ 2036.”
Id. The Court of Appeals further indicated that while
this test does not necessarily demand a transaction between a
transferor and an unrelated third party, intrafamily transfers
should be subjected to heightened scrutiny.
Id. at 382.
The approach of the Court of Appeals for the Third Circuit
correlates with this Court’s requirement of a legitimate and
significant nontax purpose for the entity. This Court has
expressed this requirement using the alternate phraseology of an
arm’s-length transaction, in the sense of “the standard for
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testing whether the resulting terms and conditions of a
transaction were the same as if unrelated parties had engaged in
the same transaction.” Estate of Bongard v. Commissioner, supra
at __ (slip op. at 46). Intrafamily or related-party
transactions are not barred under this standard, but they are
subjected to a higher level of scrutiny.
Id. at __ (slip op. at
46-47).
In probing the presence or absence of a bona fide sale and
corollary legitimate and significant nontax purpose, courts have
identified various factual circumstances weighing in this
analysis. These factors include whether the entity engaged in
legitimate business operations, whether property was actually
transferred to the entity, whether personal and entity assets
were commingled, whether the taxpayer was financially dependent
on distributions from the entity, and whether the transferor
stood on both sides of the transaction. See, e.g., Estate of
Thompson v. Commissioner, supra; Kimbell v. United States,
371
F.3d 257 (5th Cir. 2004); Estate of Bongard v.
Commissioner,
supra; Estate of Hillgren v. Commissioner, T.C. Memo. 2004-46;
Estate of Stone v. Commissioner, T.C. Memo. 2003-309; Estate of
Strangi v. Commissioner, T.C. Memo. 2003-145; Estate of Harper v.
Commissioner, T.C. Memo. 2002-121.
Hence, in evaluating whether decedent’s transfers to Schutt
I and II are properly characterized as bona fide sales, the
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essential task is to “separate the true nontax reasons for the
[entities’] formation from those that merely clothe transfer tax
savings motives.” Estate of Bongard v. Commissioner, supra at __
(slip op. at 44). It must be recognized, however, that
“Legitimate nontax purposes are often inextricably interwoven
with testamentary objectives.”
Id. Furthermore, with respect to
the particular case at bar, the Court must be cognizant of any
potential divergence between decedent’s actual motives and the
concerns of his advisers.
The estate’s position is that Schutt I and II were “formed
primarily to put into place an entity to perpetuate Mr. Schutt’s
buy and hold investment philosophy with respect to the DuPont and
Exxon stock belonging both to Mr. Schutt and to the Wilmington
Trust Company Trusts.” In service of this objective, Schutt I
and II were aimed at “the furtherance and protection of * * *
[decedent’s] family’s wealth by providing for the centralized
management of his family’s holdings in duPont [sic] stock and
Exxon stock during his lifetime and to prevent the improvident
disposition of this stock during his lifetime and to the extent
possible after his death.” The estate contends that the desired
preservation of decedent’s investment policy “could not be
accomplished without the creation of Schutt I and Schutt II, as
the WTC Trusts were scheduled to terminate at various intervals
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and the assets of those trusts would be distributed, free of
trust, to their respective beneficiaries.”
Respondent’s argument to the contrary is summarized as
follows:
(1) it was not necessary to transfer stock from
Mr. Schutt’s revocable trust to the business trusts to
perpetuate his investment philosophy; (2) the record
establishes that obtaining valuation discounts for gift
and estate tax purposes was the dominant, if not the
sole, reason for forming the business trusts; and (3)
in any event, Mr. Schutt’s desire to perpetuate his
investment philosophy was itself a testamentary motive.
* * *
The totality of the record in this case, when viewed as a
whole, supports the estate’s position that a significant motive
for decedent’s creation of Schutt I and II was to perpetuate his
buy and hold investment philosophy. That decedent was in fact a
committed adherent to the buy and hold approach is undisputed.
His longstanding concern with disposition of core stockholdings
by his descendants is also well attested. Mr. Sweeney testified
that decedent “would raise, at least annually and, quite often,
more than annually, his concern about the ability of children or
grandchildren or whoever it might be to sell principal rather
than using the income from the principal”. Mr. Dinneen likewise
testified that decedent expressed concern about Schutt family
members’ selling of stock from “Back in the early seventies and
on a regular basis from there on out.”
-49-
The documentary record also furnishes at least a measure of
objective support for the decedent’s willingness to act based on
these worries. In 1994, decedent declined to make annual
exclusion gifts of limited partnership interests in the Schutt
Family Limited Partnership to his daughter Sarah S. Harrison and
her children. The estate attributes this decision to concern
about the investment philosophy of these individuals, and the
limited evidence does reflect 13 occasions on which DuPont or
Exxon stock was sold by Harrison grandchildren from 1989 through
1997.
Further corroborating the bona fides of the professed intent
underlying creation of Schutt I and II is the fact that formation
of the business trusts did serve to advance this goal.
Respondent’s contention that the business trusts were unnecessary
to perpetuate decedent’s investment philosophy unduly emphasizes
management of the assets held by the Revocable Trust and
minimizes any focus on the considerable assets held in the WTC
trusts. Respondent points out that, under the Revocable Trust
indenture, decedent could control investment decisions pertaining
to the assets until his death, at which time various successor
trusts to be administered by his son and son-in-law would be
funded. Respondent argues that the situation under the business
trusts was functionally equivalent, with decedent as trustee
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setting investment philosophy during his lifetime, followed by
his son and son-in-law as successor trustees.
However, by only considering the Revocable Trust assets in
isolation, this analysis disregards more than half of the
property involved in the business trusts. Decedent in effect
used the assets of the Revocable Trust10 to enhance his ability
to perpetuate a philosophy vis-a-vis the stock of the WTC trusts,
such that none of the contributions should be disregarded in
evaluating the practical implications of Schutt I and II.
Mr. Howard testified that he did not believe he would have
considered a proposal involving contribution only of the WTC
trusts’ assets to entities structured as were Schutt I and II,
without decedent’s willingness to place his own property
alongside. As Mr. Howard explained: “it made real to me,
certainly, when someone is willing to contribute that sum of
money and tie it up the same way we were tying it up with respect
to distributions, if not with respect to management, that this
was something that he and the family, if they were willing to
agree to it, felt strongly about.” This importance of decedent’s
contributions to those negotiating on behalf of WTC, at least on
a psychological level, reflects a critical interconnectedness
between decedent’s contributions and those of the WTC trusts.
10
To employ an oft-used metaphor, the assets of the
Revocable Trust served essentially as leverage in the form of a
carrot.
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The effect of Schutt I and II on the assets of the WTC
trusts shows that the business trusts advanced decedent’s
objectives in a meaningful way. Respondent’s argument, however,
to the extent that it takes into account the WTC assets, seeks to
counter this conclusion by once again placing unwarranted
emphasis on certain features or results of the structure to the
exclusion of others. In discussing the alleged motive for
involving the WTC trusts in the transaction, respondent states
that “even if the decedent formed the business trusts to prevent
his heirs from dissipating the family’s wealth, this is itself a
testamentary motive.” More specifically, respondent dismisses
the estate’s contentions as follows:
The decedent’s testamentary motives are
particularly evident in this case as it is clear that
he was concerned about the dissipation of the family’s
wealth after his death as opposed to during his
lifetime. While he was alive, he controlled the sale
of stock held by his revocable trust. Similarly, as
the direction or consent advisor to the bank trusts,
none of the stock held by those entities could be sold
without his consent. The only risk that assets held by
the bank trusts could be sold without his consent was
if one of his children predeceased him, thereby causing
a distribution of a portion of the trust assets to that
child’s issue. Since his surviving children were all
in good health when the business trusts were formed and
the decedent was not, there is little doubt that the
decedent was concerned about what would happen to the
family’s wealth after his death.
The Court disagrees that decedent’s motives may properly be
dismissed, in the unique circumstances of this case, as merely
testamentary. The record on the whole supports that decedent’s
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greatest worry with respect to wealth dissipation centered on
outright distribution of assets to the beneficiaries of the
various WTC trusts. It is clear from the structures of the WTC
trusts involved that outright distribution created the single
largest risk to the perpetuation of a buy and hold philosophy,
and testimony confirmed decedent’s concern over a termination
situation. Because none of the events that would trigger such a
distribution turned on decedent’s own death, to call the
underlying motive testamentary is inappropriate.
Trust 2064, which contributed 10.346 percent of the DuPont
stock to Schutt I and 41.439 percent of the Exxon stock to Schutt
II, was to terminate, and the corpus was to be distributed free
of trust to decedent’s grandchildren, no later than when the
youngest grandchild turned 40. Notably, the health of both
decedent and his issue was irrelevant to this precipitating
event. According to the parties’ stipulations, decedent’s
youngest grandchild, Katherine D. Schutt, was 24 years of age at
the time of decedent’s 1999 death. The provisions of Trust 2064
would therefore dictate termination no later than the spring of
2015. Schutt I and II were structured to continue to 2048,
absent agreement to the contrary in accordance with limited
procedures set forth in the business trust indentures.
The Trust 3044 subtrusts, which in the aggregate contributed
42.310 percent of the DuPont stock to Schutt I and 9.099 percent
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of the Exxon stock to Schutt II, specified that at the death of a
primary beneficiary, one of decedent’s children, the assets were
to be distributed free of trust to the corresponding
grandchildren. Respondent apparently seeks to belittle any
concern decedent may have felt over these provisions by citing
the good health of decedent’s three surviving children, who were
61, 60, and 56 at the time of decedent’s death. Yet respondent
has offered no evidence contradicting the bona fides of
decedent’s fears in this regard. Nor is the Court prepared to
say that decedent, who had already lost one child to cancer and
observed firsthand the operation of the outright distribution
mechanism, would be unjustified in taking steps to guard against
this risk.
Still another aspect of the evidence in this case that
corroborates decedent’s desire to perpetuate his investment
philosophy through establishment of Schutt I and II stems from
WTC’s concerns with and reactions to the proposed arrangement.
The record indicates that WTC perceived the business trust
transactions as having a meaningful economic impact on the rights
of the beneficiaries of the WTC trusts. From early in the
planning process, representatives of WTC consistently voiced
concerns regarding the effect of the business trusts on
liquidity.
-54-
Mr. Howard testified regarding the tone of the conversation
when Mr. Helme first asked him to look into the possibility of
participating in a business trust transaction: “It was a matter
where we were going to take substantial portions of a series of
trusts and put them into a business trust where we would not have
the immediacy of control and liquidity that we had at the moment
to meet the needs of the beneficiary. That’s not an
insignificant matter to review”. Similarly, the initial March 6,
1997, memorandum from WTC to Mr. Sweeney memorializing issues of
concern to WTC explained the impetus for obtaining consents from
involved beneficiaries as follows:
Each trust’s interest in the DBT will be non-marketable
for a period of time, perhaps beyond the termination of
a trust. WTC would not normally invest marketable
assets so as to cause them to become illiquid. The
beneficiaries of the trust who are “sui juris” should,
therefore, consent to this investment. To the extent
these illiquidity concerns can be minimized by
structuring the DBT so as to allow pro rata
distributions on the occurrence of certain events,
e.g., the death of one of Mr. Schutt’s children, this
should be done.[11]
Notes made by Mr. Sweeney of a September 4, 1997, meeting with
decedent, Mr. Howard, and Ms. Hickok likewise reflect continued
emphasis by WTC representatives on the need for beneficiary
consent in conjunction with issues related to the duration of the
business trusts. As a final example, in Mr. Howard’s November
11
The Court notes that this suggestion pertaining to
distributions would manifestly have conflicted with decedent’s
objectives and was not incorporated.
-55-
26, 1997, letter agreeing to investment in Schutt I and II
subject to three conditions, the condition pertaining to consent
read:
All of the beneficiaries of the various trusts who
are of age will execute a form of consent whereby they
acknowledge and consent to the trusts’ investing in the
business trusts and that they recognize that the
business trusts may last beyond the termination date of
the trusts of which they are a beneficiary. The form
of the Delaware business trusts will be attached to the
consents.
Mr. Howard testified that the latter requirement of the just-
quoted condition was suggested and insisted upon by him to ensure
that the consent given by the beneficiaries was meaningful.
Despite the evidence discussed above, it is nonetheless
respondent’s position that tax savings through valuation
discounts constituted the dominant reason for formation of Schutt
I and II. Respondent characterizes the issue of valuation
discounts as having “dominated” the early discussions concerning
the formation of a new entity. Respondent also notes that
decedent and his advisers initially contemplated only
transferring stock from the Revocable Trust to a business trust
and emphasizes that the subsequent decision to involve the WTC
trusts served a tax purpose of making available minority as well
as marketability discounts. However, while it is clear that
estate tax implications were recognized and considered in the
initial stages of the planning process, the record fails to
reflect that such issues predominated in decedent’s thinking and
-56-
desires. What may have originally been approached as a
relatively routine estate planning transaction rapidly developed
into an opportunity and vehicle for addressing more fundamental
concerns of decedent.
As Mr. Sweeney and Mr. Dinneen acknowledged at trial, both
had a background in tax and so would naturally have taken tax and
valuation matters into account in any recommendations they made
for decedent. Yet the documentary evidence and testimony fall
short of enabling the Court to infer that decedent himself was
principally focused on tax savings. To the contrary, the record
compiled over the course of the ensuing year suggests otherwise.
The valuation questions evaluated by decedent’s advisers in
February and early March of 1997 were left virtually untouched
throughout the remaining approximately 12 months of the planning
and formation process. Furthermore, to the extent that the notes
taken by Mr. Sweeney of meetings involving decedent enable us to
identify the particular concerns or comments emphasized by
decedent himself, these concerns never touch on valuation
discounts. Rather, there is a notable focus on matters such as
decedent’s desire for investment control. Additionally, in the
letters sent by Mr. Sweeney to decedent for purposes of updating
him on the progress of negotiations and presumably focusing on
issues about which decedent would be most interested, transfer
tax issues are nearly absent. Thus, the proffered evidence is
-57-
insufficient to establish that estate tax savings were decedent’s
predominant reason for forming Schutt I and II and to contradict
the estate’s contention that a true and significant motive for
decedent’s creation of the entities was to perpetuate his buy and
hold investment philosophy.
Given this conclusion regarding decedent’s motive, the
question then becomes whether perpetuation of a buy and hold
investment strategy qualifies as a “legitimate and significant
nontax reason” within the meaning of Estate of Bongard v.
Commissioner, 124 T.C. at __ (slip op. at 39). As respondent
points out, the buy and hold investment philosophy by definition
resulted in passive entities designed principally to hold the
DuPont and Exxon stock. Active management, trading, or
“churning” of the portfolios as a means of generating profits was
not intended. Furthermore, because each trust was funded with
the stock of a single issuer, asset diversification did not
ensue.
The Court of Appeals for the Third Circuit has in a similar
vein suggested that the mere holding of an untraded portfolio of
marketable securities weighs negatively in the assessment of
potential nontax benefits available as a result of a transfer to
a family entity. Estate of Thompson v. Commissioner, 382 F.3d at
380. As a general premise, this Court has agreed with the Court
of Appeals, particularly in cases where the securities are
-58-
contributed almost exclusively by one person. See Estate of
Strangi v. Commissioner, T.C. Memo. 2003-145; Estate of Harper v.
Commissioner, T.C. Memo. 2002-121. In the unique circumstances
of this case, however, a key difference exists in that decedent’s
primary concern was in perpetuating his philosophy vis-a-vis the
stock of the WTC trusts in the event of a termination of one of
those trusts. Here, by contributing stock in the Revocable
Trust, decedent was able to achieve that aim with respect to
securities of the WTC trusts even exceeding the value of his own
contributions. In this unusual scenario, we cannot blindly apply
the same analysis appropriate in cases implicating nothing more
than traditional investment management considerations.
To summarize, the record reflects that decedent’s desire to
prevent sale of core holdings in the WTC trusts in the event of a
distribution to beneficiaries was real, was a significant factor
in motivating the creation of Schutt I and II, was appreciably
advanced by formation of the business trusts, and was unrelated
to tax ramifications. The Court is thus able to conclude in this
case that Schutt I and II were formed for a legitimate and
significant nontax purpose without further probing the parties’
disagreement as to whether, in theory, an investment strategy
premised on buy and hold should offer just as much justification
for an entity premised thereon as a philosophy that focuses on
active trading.
-59-
As regards other factors considered indicative of a bona
fide sale, these too tend to support the estate’s position. The
contributed property was actually transferred to Schutt I and II
in a timely manner. Entity and personal assets were not
commingled. Decedent was not financially dependent on
distributions from Schutt I and II, retaining sufficient assets
outside of the business trusts amply to support his needs and
lifestyle. Nor was decedent effectively standing on both sides
of the transactions.
Concerning this latter point, it is respondent’s position
that “there were no ‘arm’s-length negotiations’ between the
decedent and the bank concerning any material matters affecting
the formation and operation of the business trusts.” Respondent
maintains that WTC, while ostensibly an independent third party,
simply represented the interests of decedent’s children and
grandchildren and that decedent dictated all material terms.
The Court, however, is unpersuaded by respondent’s attempts
to downplay the give-and-take reflected in the record. As
detailed in the facts recounted above and the stipulated
exhibits, WTC representatives thoroughly evaluated the business
trust proposals, raised questions, offered suggestions, and made
requests. Some of those suggestions or requests were accepted or
acquiesced in; others were not. Such a scenario bears the
earmarks of considered negotiations, not blind accommodation.
-60-
There is no prerequisite that arm’s-length bargaining be strictly
adversarial or acrimonious.
Regardless of whether the Schutt I and II transactions
should be subjected to the heightened scrutiny appropriate in
intrafamily situations, the record here is sufficient to show
that the negotiations and discussions were more than a mere
facade.12 The Court concludes that the transfers to Schutt I and
II satisfy the bona fide sale requirement for purposes of
sections 2036 and 2038.
Adequate and Full Consideration
In this Court’s recent discussion of the adequate and full
consideration prong in Estate of Bongard v. Commissioner, 124
T.C. at __ (slip op. at 48-49), four factors were noted in
support of a finding that the consideration requirement had been
met: (1) The interests received by the participants in the
12
The Court also notes that Wilmington Trust Company (WTC)
was founded in 1903 by the duPont family and has among its
clients numerous duPont descendants. According to public filings
with the Securities and Exchange Commission, WTC subsequently
became the principal operating and banking entity of Wilmington
Trust Corporation, a financial holding company which as of Dec.
31, 1997, was publicly traded with 33,478,113 shares outstanding
and 10,164 shareholders of record, had total assets of $6.12
billion, and possessed stockholders’ equity of $503 million.
Given this size and scope, WTC’s historical connection to the
duPont family is not germane to our analysis. Likewise, although
Mr. Sweeney has served as a director of WTC and/or Wilmington
Trust Corporation since 1983 and his firm has served as outside
counsel to WTC, he during 1997 was one of 21 directors, and both
Mr. Sweeney and Mr. Howard testified credibly that the
relationship made the participants more circumspect, rather than
less, in their dealings.
-61-
entity at issue were proportionate to the value of the property
each contributed to the entity; (2) the respective assets
contributed were properly credited to the capital accounts of the
transferors; (3) distributions from the entity required a
negative adjustment in the distributee’s capital account; and (4)
there existed a legitimate and significant nontax reason for
engaging in the transaction. Given these circumstances, we
concluded that the resultant discounted value attributable to
entity interest valuation principles was not per se to be equated
with inadequate consideration. Id. at __ (slip op. at 49-50).
The Court of Appeals for the Third Circuit has likewise
opined that while the dissipated value resulting from a transfer
to a closely held entity does not automatically constitute
inadequate consideration for section 2036(a) purposes, heightened
scrutiny is triggered. Estate of Thompson v. Commissioner, 382
F.3d at 381. To wit, and consistent with the focus of the Court
of Appeals in the bona fide sale context, where “the transferee
partnership does not operate a legitimate business, and the
record demonstrates the valuation discount provides the sole
benefit for converting liquid, marketable assets into illiquid
partnership interests, there is no transfer for consideration
within the meaning of § 2036(a).”
Id.
In reaching this conclusion, the Court of Appeals referenced
the “recycling” of value concept first articulated by this Court
-62-
in Estate of Harper v. Commissioner, T.C. Memo. 2002-121. Estate
of Thompson v. Commissioner, supra at 378-381. As we explained
with respect to the situation before us in Estate of Harper v.
Commissioner, supra:
to call what occurred here a transfer for consideration
within the meaning of section 2036(a), much less a
transfer for an adequate and full consideration, would
stretch the exception far beyond its intended scope.
In actuality, all decedent did was to change the form
in which he held his beneficial interest in the
contributed property. We see little practical
difference in whether the Trust held the property
directly or as a 99-percent partner (and entitled to a
commensurate 99-percent share of profits) in a
partnership holding the property. Essentially, the
value of the partnership interest the Trust received
derived solely from the assets the Trust had just
contributed. Without any change whatsoever in the
underlying pool of assets or prospect for profit, as,
for example, where others make contributions of
property or services in the interest of true joint
ownership or enterprise, there exists nothing but a
circuitous “recycling” of value. We are satisfied that
such instances of pure recycling do not rise to the
level of a payment of consideration. To hold otherwise
would open section 2036 to a myriad of abuses
engendered by unilateral paper transformations.
Respondent contends that the instant case features the genre
of value recycling described in Estate of Harper v. Commissioner,
supra, and subsequent cases such as Estate of Strangi v.
Commissioner, T.C. Memo. 2003-145. Respondent, stressing that
decedent enjoyed all incidents of ownership related to the
contributed stock both before and after the transfers (e.g., the
right to the income generated, the right to sell the stock and
reinvest the proceeds, the right to vote the shares), maintains
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that contribution to Schutt I and II engendered no meaningful
change in decedent’s relationship to the assets.
Again, however, this reasoning disregards unique factual
circumstances present in this case that were not involved in
Estate of Harper v. Commissioner, supra, and its progeny.
Undoubtedly, looking in isolation at the relationship of a
decedent to his or her assets may be sufficient where the
decedent’s contributions make up the bulk of the property held by
the relevant entity and no suggestion of any benefit beyond
change in form is evident. Yet here, where others contributed
more than half of the property funding the entities and the
record reflects that decedent used his own assets primarily to
alter his relationship vis-a-vis those other assets, the analysis
must look more broadly at the transactions. In that decedent
employed his capital to achieve a legitimate nontax purpose, the
Court cannot conclude that he merely recycled his shareholdings.
Furthermore, with respect to the additional criteria cited
in Estate of Bongard v. Commissioner, supra at ___ (slip op. at
48-49), each participant in Schutt I and II received an interest
proportionate in value to its respective contribution, the
capital contributions made were properly credited to each
transferor’s capital account, and distributions required a
negative adjustment in the distributee’s capital account.
Liquidating distributions would also be made in accordance with
-64-
capital account balances. Hence, existing precedent shows that
decedent is considered to have received adequate and full
consideration as used in sections 2036(a) and 2038 for his
transfers to Schutt I and II.
II. Conclusion
The Court has concluded in the unique circumstances of this
case that decedent’s transfers to Schutt I and II constitute bona
fide sales for adequate and full consideration for purposes of
sections 2036(a) and 2038. Because the record supports finding
that both prongs of this test have been met, respondent has
failed to carry the burden of proving otherwise. Accordingly,
the transfers to Schutt I and II are excepted from inclusion in
decedent’s gross estate under either section 2036(a) or 2038.
The Court therefore need not probe other arguments by the parties
with regard to the application of these statutes.
To reflect the foregoing and to give effect to the parties’
stipulations,
Decision will be entered
under Rule 155.
