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Citizens Bank & Trust Co. v. Commissioner of Internal Revenue

decided: February 16, 1988.


Appeal from an Order of the United States Tax Court.

Posner and Flaum, Circuit Judges, and Eschbach, Senior Circuit Judge.

Author: Posner

POSNER, Circuit Judge.

This appeal from the Tax Court presents a difficult question in the administration of the federal gift and estate taxes. The essential facts are simple, however. After a merger of several commonly owned corporations, four siblings -- John and William Curran, Cecilia Simon, and Judy Pokorny -- each owned 25 percent of both the voting and nonvoting common stock of the Curran Contracting Company. The company is a substantial corporation involved in manufacturing, distribution, and real estate. It is managed by John and William Curran. The four siblings wanted to maintain family ownership and control of the enterprise as far into the future as possible. To this end, on May 7, 1976, acting in concert, each of the four created identical trusts, named "76-1," to which each transferred all of his or her voting stock. On the same day, all but Judy Pokorny created identical trusts named "76-2" to which each transferred all of his or her nonvoting stock. Each 76-1 trust made the brothers co-trustees with power to appoint their successors, and made the settlors -- and the settlors' descendants as far into the future as the Rule Against Perpetuities permits -- the beneficiaries. The terms of the 76-2 trusts were the same as those of the 76-1 trusts except that the grantor's spouse (rather than brother) was the initial trustee. Each trust in both series was to become irrevocable after 20 days or upon the death of the settlor, whichever occurred first. It was estimated that, unless revoked within the 20-day period, each trust would last for 97 years from the date of its creation.

Cecilia Simon died on May 11, whereupon the trust that she had created became irrevocable. The trusts of the two brothers, along with Judy Pokorny's 76-1 trust (remember that she had created no 76-2 trust), became irrevocable on May 27, not having been revoked previously. So there were four irrevocable 76-1 trusts and three irrevocable 76-2 trusts.

The parties agreed that estate tax was due on the transfer of stock to Cecilia Simon's trust and that gift tax was due on the transfers of stock to the trusts that became irrevocable on May 27 by the terms of the trust instruments. But the Internal Revenue Service was not satisfied with the valuation placed on the stock by John and William Curran and by Cecilia's estate, and assessed deficiencies which the taxpayers contested in the Tax Court.

At trial each side presented an expert witness on valuation. The principal disagreement between the experts, and the only one we need discuss, concerned the "marketability discount" for the stock in the 76-2 trusts. Stock in closely held corporations is not so freely marketable as stock that can readily be liquidated by sale in a public market, so it is worth less. See generally Fellows & Painter, Valuing Close Corporations for Federal Wealth Transfer Taxes: A Statutory Solution to the Disappearing Wealth Syndrome, 30 Stan. L. Rev. 895, 916-21 (1978). The taxpayers' expert took the position that anyone buying nonvoting stock from any of the three taxpayers on the eve of the trusts' becoming irrevocable would have insisted on a 90 percent discount from what would otherwise be the fair market value. Such a buyer would know that 75 percent of the corporation's voting stock would be locked up for 97 years, making it well-nigh impossible for this buyer to gain control of the company -- for he would acquire no voting rights at all and he could hardly expect to persuade the trustees of the voting stock (John and William Curran, or successor trustees appointed by them) to sell stock held by the trusts to him at a reasonable price. The buyer would know, moreover, that a major reason for establishing the trusts had been to ensure that the corporation remained in the control of persons who would refrain (to the extent allowed by the Internal Revenue Code) from paying dividends and would instead plow all corporate earnings back into the company so that it would provide better employment and investment opportunities for future generations of Currans.

The government's expert disregarded the terms of the trusts and testified that a 20 percent discount for lack of ready marketability was the highest that could be justified. The government's position was that the value of the stock transferred to the trusts must be determined without regard to the terms or indeed existence of the trusts. The Tax Court agreed.

It is hard to believe that the terms of the trusts could make as much difference in the marketability of the stock as the discrepancy between the two discounts for marketability implies. Investors drastically discount events in the far future; at a discount rate of 10 percent a year, the present value of a dollar to be received in 50 years is less than one cent. The real impediment to the ready marketability of stock in Curran Contracting Company is, not trusts intended to perpetuate that ownership and control into the far future, but family ownership and control. But the quarrel in this case isn't over the reasonableness of the experts' different valuations given their assumptions; it is over the assumptions. The issue is whether the terms of the trusts should have been taken into account in valuing the shares, as the government's expert refused to do.

A gift to a revocable trust does not take effect for purposes of gift or estate tax until the trust becomes irrevocable. Burnet v. Guggenheim, 288 U.S. 280, 77 L. Ed. 748, 53 S. Ct. 369 (1933); 5 Bittker, Federal Taxation of Income, Estates and Gifts para. 122.3.1 (1984). Cecilia Simon's two trusts became irrevocable when she died on May 11, so May 11 is the date of the gifts of her stock to the trusts. The trusts of her two brothers became irrevocable on May 27, so May 27 is the date of their gifts of stock to the 76-2 trusts. It is, of course, the date the three 76-1 trusts (all but Cecilia Simon's) became irrevocable as well. But as there was less disagreement between the experts on the valuation of those trusts, we shall not have to discuss them separately, and can confine our attention to the valuation of 25 percent of the nonvoting common stock on May 11, and of each of two 25 percent chunks of the same stock on May 27. The relevant concept of value, the parties agree, is market price, the price the owner of the shares would have gotten on these dates by selling the shares in an arm's length transaction rather than giving them away.

The government relies on a line of cases that infer from this definition that value is to be measured at the instant before transfer, so that the amount of tax depends on the value of the transferred property in the hands of the transferor rather than its value in the hands of the transferee. See Estate of Curry v. United States, 706 F.2d 1424, 1426-30 (7th Cir. 1983); Ahmanson Foundation v. United States, 674 F.2d 761, 767-69 (9th Cir. 1981); cf. Ithaca Trust Co. v. United States, 279 U.S. 151, 155, 73 L. Ed. 647, 49 S. Ct. 291 (1929); YMCA v. Davis, 264 U.S. 47, 50, 68 L. Ed. 558, 44 S. Ct. 291 (1924). In Ahmanson, the leading case in the line and incidentally the one with facts closest to those of the present case, the owner of all 100 shares of the common stock of a corporation, consisting of one share of voting stock and 99 shares of nonvoting stock, bequeathed the nonvoting stock to a charitable foundation and the single voting share in trust for his son. The district court discounted the value of the nonvoting stock because of its lack of voting rights, but the court of appeals reversed and held that the 100 shares should be valued as a unit representing full ownership and control of the corporation.

Ahmanson is in some tension with Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981) (en banc), and cases following it such as Estate of Andrews v. Commissioner, 79 T.C. 938, 953-56 (1982), and Ward v. Commissioner, 87 T.C. 78, 106-09 (1986). All of these cases reject what is called the "family attribution" doctrine. See generally Comment, Estate of Bright and Propstra: Rejection of Family Attribution in Estate Valuation, 2 Va. Tax. Rev. 357 (1983). In Estate of Bright, a husband and wife owned 55 percent of a corporation's stock as community property, signifying joint ownership until the community was dissolved by death or divorce. The wife died, leaving her shares in trust for their children, with the husband as trustee. The court refused to allow the government to value the shares in the trust as part of a control bloc. It held that they should be valued as if Mrs. Bright had left them to a stranger, thus destroying the bloc. Yet the shares had been worth more than that at the instant before transfer, that is, before her death, because they were then part of a control bloc; so under Ahmanson one might have expected them to be valued at the higher rate.

Ahmanson does not discuss Estate of Bright ; and although Foltz v. U.S. News & World Report, Inc., 663 F. Supp. 1494, 1525 (D.D.C. 1987), says that the two lines of cases are easily reconciled, the court does not make clear the basis of its confidence. Nor do we get much help from being told that "brief as is the instant of death, the court must pinpoint its valuation at this instant" -- the much-cited but enigmatic formulation in United States v. Land, 303 F.2d 170, 172 (5th Cir. 1962), relied on in Estate of Bright, see 658 F.2d at 1001-02. At the instant of Mrs. Bright's death, two offsetting events occurred; her shares were freed up from the restrictions imposed by community-property law that had created the control bloc of her and her husband's shares, and the shares came into the hands of Mr. Bright as trustee of the trust created by her will, thus reimposing the restrictions. Yet the court refused to consider the restrictions.

What the two lines of cases -- inconsistent though they well may be in an important sense -- have in common is an unwillingness to take into account, for purposes of valuation, terms or restrictions in the instrument of transfer itself. (In contrast, restrictions imposed before transfer are taken into account, provided they are not motivated by a desire to avoid gift or estate tax. See, e.g., Estate of Bischoff v. Commissioner, 69 T.C. 32, 39-40 (1977); Estate of Littick v. Commissioner, 31 T.C. 181, 185-86 (1958). We consider the rationale for distinguishing between transfer and pre-transfer restrictions later in this opinion.) Strip away the restrictions in Mrs. Bright's will, and the transfer in Estate of Bright was of shares that by virtue of Mrs. Bright's death were severed from her husband's, thereby destroying the control bloc. Strip away the term in Ahmanson's will splitting his corporate interest into two units, and the transfer was of the full ownership and control of the corporation. And strip away the restrictions in the trusts of the Curran siblings and what is left are unencumbered shares ...

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