Shepherd v. Commissioner
115 T.C. No. 30, 2000 U.S. Tax Ct. LEXIS 77, 115 T.C. 376 (2000)
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Rule of Law:
The federal gift tax is imposed on the value of property transferred by a donor, not on what the donee receives. A transfer of property by a donor to a partnership for less than adequate consideration constitutes an indirect gift to the other partners to the extent of their proportionate interests in the partnership, and these indirect gifts of fractional interests are subject to appropriate valuation discounts.
Facts:
- Petitioner J.C. Shepherd's grandfather, starting in 1911, acquired extensive land and stock in three Alabama banks.
- In April 1949, J.C. Shepherd inherited a 25-percent interest in his grandfather's land and bank stock.
- Prior to 1957, J.C. Shepherd's father gave him an additional 25-percent interest in the land, bringing J.C. Shepherd's ownership to 50-percent.
- On January 3, 1957, J.C. Shepherd and his father leased 9,091 acres of land (the leased land) to Hiwassee Land Co. under a 66-year timber lease set to expire on January 1, 2023.
- In 1965, J.C. Shepherd inherited his father's remaining 50-percent interest in the land and bank stock from his mother, making him the 100-percent owner of the leased land (subject to the timber lease) and a majority owner of the bank stock.
- Around December 22, 1980, J.C. Shepherd and his wife established a 'Clifford' trust, conveying two 25-percent undivided interests (50-percent total) in the leased land to the trust for his sons, John Phillip Shepherd and William David Shepherd, as equal income beneficiaries.
- On April 1, 1991, the 'Clifford' trust terminated, and the 50-percent undivided interest in the leased land was reconveyed to J.C. Shepherd and his wife.
- On August 1, 1991, J.C. Shepherd executed the Shepherd family partnership agreement, forming a general partnership with himself as managing partner (50-percent interest) and his sons, John and William, each with 25-percent interests.
- Also on August 1, 1991, J.C. Shepherd and his wife executed two deeds purporting to transfer the entire leased land to the then-nonexistent partnership.
- On August 2, 1991, John and William executed the partnership agreement, officially forming the Shepherd family partnership.
- On August 30, 1991, the deeds conveying the leased land to the partnership were recorded.
- On September 9, 1991, J.C. Shepherd transferred some of his stock in the three banks to the Shepherd family partnership.
Procedural Posture:
- J.C. Shepherd filed Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for calendar year 1991, reporting gifts to his sons, John and William, of interests in the leased land and bank stock, valuing the leased land at $400,000 and the bank stock at $792,386 (after a 15-percent minority discount), and reporting no gift tax due.
- The Respondent (Commissioner of Internal Revenue) issued a notice of deficiency, determining a $168,577 deficiency in J.C. Shepherd’s Federal gift tax for 1991, primarily by valuing the 50-percent interest in leased land gifted to his sons at $639,300 (implying a value of $1,278,600 for J.C. Shepherd’s entire interest) but making no adjustment to the bank stock value.
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Issue:
Does a donor's transfer of property (leased land and bank stock) to a family general partnership, in which the donor and his sons are partners, constitute indirect gifts of fractional interests in the underlying assets to the sons, thereby entitling the donor to apply fractional interest and minority discounts in valuing the gifts for federal gift tax purposes?
Opinions:
Majority - Thornton, Judge
Yes, J.C. Shepherd's transfers to the family general partnership represent indirect gifts to his sons of undivided fractional interests in the underlying leased land and bank stock, and these gifts are properly subject to valuation discounts. The court determined that any gift was not completed before August 2, 1991, because the partnership, and thus the donees, did not exist prior to that date. Citing Gift Tax Regs. § 25.2511-1(h)(1) and cases like Kincaid v. United States, the court characterized the transfers to the partnership for less than full consideration as indirect gifts to the other partners to the extent of their proportionate interests. The court reaffirmed that the gift tax is an excise tax on the transfer of property, measured by what the donor transfers, not what the donee receives, and therefore rejected the petitioner's constitutional challenge. For valuation, the court aggregated J.C. Shepherd's transfers of the leased land to reflect the economic substance of conveying his entire interest to the partnership but did not aggregate the separate indirect gifts to his sons. The valuation of the leased land incorporated the present value of projected lease income and the reversionary interest, applying a nominal discount rate (converted to 12.3% pretax) that accounted for inflation adjustments in the lease and the illiquidity/lack of marketability of an undivided interest. The court accepted a 15-percent fractional interest discount for the leased land and a 15-percent minority interest discount for the bank stock, as stipulated, because these discounts reflected the characteristics of the indirectly gifted fractional interests. The combined value of the separate indirect gifts to each son was determined to be $358,973.
Dissenting - Foley, J.
No, the majority's reasoning is contradictory. While relying on Kincaid v. United States to support the idea that gifts can 'enhance the value of her sons’ voting stock,' the majority simultaneously rejects the petitioner’s contention that his transfers should be characterized as 'enhancements of his sons’ existent partnership interests.' This inconsistency undermines the basis for the majority's conclusion derived from Kincaid.
Concurring - Whalen, J.
Yes, I agree with the majority's reasoning and result. I write to clarify that the approach in this case, where the valuation of gifts to sons does not differ whether aggregated or separate, is distinct from Estate of Bosca v. Commissioner. The key principle remains that separate gifts are valued separately. I also emphasize that allowing minority and fractional interest discounts is consistent with valuing the property transferred by the donor. These discounts reflect the nature of the property itself, not restrictions imposed by the conveyance, and are therefore permissible for both direct and indirect gifts, aligning with the willing buyer, willing seller standard.
Concurring - Halpern, J.
Yes, I agree with the majority that a fractional interest discount is appropriate. The application of the indirect gift rule, as found in Gift Tax Regs. § 25.2511-1(h)(1) and cases like Kincaid v. United States, implies that a single transfer to a partnership is to be viewed as separate gifts to the individual partners. Therefore, it would be inconsistent and anomalous to deny fractional interest discounts for these indirect gifts, which would certainly be allowed if the gifts were made directly. The 'property transferred' should be viewed as the fractional interest transferred by virtue of each deemed separate gift, justifying the discount.
Concurring in part and dissenting in part - Ruwe, J.
No, a 15-percent valuation discount for undivided fractional interests in the leased land is not appropriate. The transfer in question was of J.C. Shepherd's entire interest in the leased land to the partnership, not of undivided interests to his sons. Under IRC Section 2512(b) and Commissioner v. Wemyss, the gift tax measures the value of the property passing from the donor, not what the donee receives. The value of the gift should be the fair market value of the property transferred to the partnership, minus the value that enhanced J.C. Shepherd's retained 50-percent partnership interest. The partnership held the same property interest as J.C. Shepherd before the transfer, so there was no fractionalization of ownership at the donor level that would justify such a discount. The court's reliance on Estate of Bosca for this point is, in my opinion, incorrect, as other cases did not permit such discounts based on hypothetical fractionalized interests when the entire interest was transferred to an entity.
Concurring in part and dissenting in part - Beghe, J.
No, the transfer of the leased land should not be valued as separate indirect transfers to the sons of individual 25-percent interests. While I agree that the donor is not entitled to 'entity level discounts,' the 'estate depletion theory' of the gift tax, which measures what is withdrawn from the donor's estate, requires that simultaneous or contemporaneous gifts to one's beneficiaries be 'unitized' for valuation purposes. The gift tax and estate tax are meant to work together, focusing on what leaves the transferor's hands. I would value the gross gift as J.C. Shepherd's entire interest in the leased land and then subtract the value of the 50-percent partnership interest he received and retained, rather than applying discounts based on hypothetical fractional interests purportedly received by the donees.
Analysis:
This case is significant for clarifying how gifts made through transfers to family partnerships are characterized and valued for gift tax purposes. It reaffirms the principle that the gift tax is measured by what the donor transfers, not what the donee receives, but simultaneously holds that when a transfer to an entity constitutes an indirect gift to other partners, those indirect gifts are of proportionate, undivided interests in the underlying assets. This allows for the application of fractional interest and minority discounts, providing a mechanism for taxpayers to legitimately reduce the taxable value of gifts made through family entities. The split opinions highlight the ongoing tension in gift tax valuation between the 'estate depletion' theory and the practical application of discounts for interests that are not freely marketable or controlled, underscoring the complexities and the critical role of expert valuation evidence in such cases.
