416 F.3d 442 (5th Cir. 2005), 03-60855, Estate of Baird v. C.I.R.

Docket Nº:03-60855.
Citation:416 F.3d 442
Party Name:ESTATE OF John L. BAIRD, Deceased, Ellen B. Kirkland and J. Samuel Baird, Co-Executors, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Estate of Sarah W. Baird, Deceased, Ellen B. Kirkland and J. Samuel Baird, Co-Executors, Petitioner-Appellant, v. Commissioner of Internal Revenue, Respondent-Appellee.
Case Date:July 11, 2005
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit
 
FREE EXCERPT

Page 442

416 F.3d 442 (5th Cir. 2005)

ESTATE OF John L. BAIRD, Deceased, Ellen B. Kirkland and J. Samuel Baird, Co-Executors, Petitioner-Appellant,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Estate of Sarah W. Baird, Deceased, Ellen B. Kirkland and J. Samuel Baird, Co-Executors, Petitioner-Appellant,

v.

Commissioner of Internal Revenue, Respondent-Appellee.

No. 03-60855.

United States Court of Appeals, Fifth Circuit.

July 11, 2005

Page 443

Appeal from the Decision of the United States Tax Court

William T.F. Dykes (argued), Shreveport, LA, for Baird.

Bethany Buck Hauser (argued), Richard Bradshaw Farber, Eileen J. O'Connor, Asst. Atty. Gen., U.S. Dept. of Justice, Charles Casazza, Clerk, U.S. Tax Court, Emily A. Parker, Donald L. Korb, Chief Counsel, IRS, Washington, DC, for CIR.

Before JOLLY and DAVIS, Circuit Judges, and ENGELHARDT, District Judge. 1

E. GRADY JOLLY, Circuit Judge:

The Tax Court held that the taxpayers, the estates of a deceased husband and wife, were not entitled to an award of administrative and litigation costs because the Commissioner of Internal Revenue ("IRS") was substantially justified in taking the position that the only discount allowable when valuing the decedents' non-controlling fractional interests in Louisiana timberland was the cost of partitioning the property. The taxpayers appeal, contending that the IRS did not meet its burden of proving that its position was substantially justified. We conclude that the Tax Court abused its discretion by finding that the IRS's position was substantially justified. Accordingly, we REVERSE and REMAND for a determination of reasonable fees and costs.

I

John L. Baird ("Mr. Baird") died on December 18, 1994. His estate included a 14/65 undivided interest in a Louisiana trust that held 2,957 acres of timberland in 16 noncontiguous tracts in Sabine Parish, Louisiana, ranging in size from one-half acre to 1,092 acres. 2 Mr. Baird's widow, Sarah W. Baird ("Mrs. Baird"), died less

Page 444

than a year later, on November 2, 1995. Her estate included a 17/65 interest in the same trust.

Mr. Baird's estate filed its initial estate tax return on March 18, 1996. His estate claimed a 25% fractionalization discount from the pro rata fair market value of his 14/65 interest in the 16 tracts held by the trust. 3

Mrs. Baird's estate filed its initial estate tax return on January 31, 1997. Her estate claimed a 50% fractionalization discount from the pro rata fair market value of her 17/65 interest in the 16 tracts held by the trust. On February 24, 1997, Mr. Baird's estate filed an amended estate tax return, and a claim for a refund, using a 50% fractionalization discount for the 16 tracts.

The IRS issued notices of proposed adjustments on June 26, 1998, rejecting the estates' claimed fractionalization discounts, and setting forth the agency's position that the only discount should be the estimated costs of a hypothetical partition in kind. That position was based on the report of an IRS forester, Robert Baker. A copy of his report was attached to the notices of proposed adjustments.

Concluding that there were no reliable market comparable sales, Baker's explanation for his opinion, relating to Mr. Baird's estate, is as follows:

Using the recommended full interest value for the 2,957 acres of $4,685,331, a discount can be determined using a cost of a revised timber inventory, surveying the property into equal valued "lots" and legal costs associated with the partition of the property. Dividing the property into 40 acre "lots", or variations thereof, and an estimated $1,000 per survey mile results in survey cost[s] of $49,250. A revised timber inventory would cost $8,871. Legal cost, as recommended by the Estate Agent, would approximate $100,000. The total cost of partition would approximate $158,121. Louisiana law cites all partition cost [s] are borne in the pro-rata share of ownership. Subtracting the partition cost of $158,121 from the recommended value of $4,685,331, results in an after cost value of $4,527,210. Mr. John Baird owned a 14/65th interest in the property or a total recommended estate value [of] $975,091.

Baker made similar calculations for Mrs. Baird's 17/65 interest. The estimated costs were equivalent to discounts of 3.37% for Mr. Baird's estate and 3.11% for Mrs. Baird's estate.

In August 1998, the estates filed protest letters in response to the notices of proposed adjustments. Attached to the protest letters were expert reports responding

Page 445

to Baker's analysis, criticizing Baker's use of transactions involving sales of controlling interests, and explaining the risks and difficulties involved with partitioning the 16 tracts. The protest letters stated that, under the circumstances, any attempt to partition the 16 tracts would be vigorously resisted by the remaining co-owners.

The parties attended an Appeals Conference in Shreveport, Louisiana, on October 20, 1998. At that conference, counsel for the estates offered to settle for a 45% fractionalization discount. That offer was not accepted. 4

On February 24, 1999, the co-executors sent a letter to the IRS Appeals Office repeating their offer to settle for a 45% fractionalization discount. The letter stated that the offer would remain open only until March 17, 1999, the day before the expiration of the three-year limitation period for filing a notice of deficiency. The IRS did not respond to this letter.

The IRS issued notices of deficiency on March 4, 1999. In the notices of deficiency, the agency took the same position -- that the only discount from fair market value should be the cost of partitioning the property, based on Baker's report. The notices of deficiency sought to collect additional tax from each estate based on valuation of the tracts at the exact amounts set forth in Baker's report.

On March 18, 1999, Mr. Baird's estate filed a second claim for refund based on increasing the fractionalization discount from 50 to 60%. Mrs. Baird's estate filed a claim for a refund on May 11, 1999, based on increasing the fractionalization discount from 50 to 60%.

On May 10, 1999, both estates filed in the Tax Court petitions for redetermination of deficiencies. In its answers to the petitions, the IRS asserted the same position it had asserted in the notices of deficiency: that the only discount allowable was the estimated cost of a hypothetical partition in kind, as calculated in the Baker report.

An IRS Appeals Officer attempted to arrange another Appeals Conference in Houston to discuss settlement of the valuation issue, but the estates refused to authorize their counsel to attend unless the IRS would first agree to a minimum fractionalization discount of 45%. The IRS would not agree, and so the conference did not take place. On the eve of trial, the IRS offered to discuss settlement with counsel for the estates. According to the Tax Court's opinion, that discussion was futile because counsel for the estates demanded a 70% fractionalization discount.

On April 13, 2000, a little over a month prior to trial, the estates served on the IRS the expert witness reports of James A. Young, Lewis C. Peters, and James C. Steele, III. All of these reports contain a discussion of the costs, time, and risks involved in a partition proceeding. Attached as an appendix to Peters's report is a report prepared by Edward Benjamin, a Louisiana attorney, setting forth his opinion on the time, costs, and other difficulties in obtaining a partition of property in Louisiana. Another appendix to Peters's report states that recently the IRS had issued a Technical Advice Memorandum that stated a new position by the IRS with respect to discounts for undivided ownership interests in real estate: A discount

Page 446

for an undivided interest will be limited to the petitioner's pro-rata share of the estimated cost of a partition of the property. Peters states that, in arriving at this conclusion, the IRS was either unaware of or ignored a significant body of data suggesting that the discounts for undivided interests should be significantly higher than the pro rata share of the estimated cost of partition.

At trial, the estates presented one fact witness and three expert witnesses. The IRS offered Francis X. Burns as an expert witness, but the Tax Court ruled that he was incompetent to testify as an expert. Baker was listed as a witness for the IRS in its trial memorandum and he prepared an expert witness report, but he did not testify at trial and his report was not offered into evidence at trial.

The Tax Court held that the estates had established 55% as the average amount by which non-controlling fractional interests in Louisiana timberland are discounted, and that an additional 5% discount was appropriate in these cases due to peculiar circumstances with respect to the decedents' remaining family members.

The estates moved for an award of reasonable litigation costs and administrative expenses. The Tax Court denied the motion, holding that the position taken by the IRS in the administrative and judicial proceedings was substantially justified.

II

A

A prevailing party in a tax case may be awarded reasonable administrative and litigation costs under 26 U.S.C. § 7430. Generally, a prevailing party is one who has substantially prevailed with respect to the amount in controversy or with respect to the most significant issue or issues. 26 U.S.C. § 7430 (c) (4) (A) (i) (I) and (II). However, "[a] party shall not be treated as the prevailing party ... if the United States establishes that the position of the United States in the proceeding was substantially justified." 26 U.S.C. § 7430(c)(4)(B)(i).

The IRS has the...

To continue reading

FREE SIGN UP