Conway v. Comm'r of Internal Revenue (In re Estate of Jung)

• Decision Date: 10 November 1993
• Docket Number: No. 20221–88.,20221–88.
• Citation: 101 T.C. 412,101 T.C. No. 28
• Parties: ESTATE OF Mildred Herschede JUNG, Deceased, Ruth J. Conway, Executrix, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

101 T.C. 412
101 T.C. No. 28

ESTATE OF Mildred Herschede JUNG, Deceased, Ruth J. Conway, Executrix, Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 20221–88.

United States Tax Court

Nov. 10, 1993.

[101 T.C. 412]

Michael E. Neiheisel, James M. Moore, Paul D. Ratterman, and Thomas H. Clark, Cincinnati, OH, for petitioner.

Joseph P. Grant, Cincinnati, OH, for respondent.

CHABOT, Judge:

Respondent determined a deficiency in Federal estate tax against petitioner in the amount of $2,396,902.92. By amendment to answer, respondent asserts

[101 T.C. 413]

an addition to tax of $719,070.90 under section 6660 ¹ (valuation understatement).

After concessions by both sides, the issues are as follows:

(1) What the fair market value of decedent's 168,600 shares of Jung Corp. stock was on the date of her death (Oct. 9, 1984); and

(2) whether petitioner is liable for an addition to tax under section 6660.

FINDINGS OF FACT ²

Some of the facts have been stipulated; the stipulation and the stipulated exhibits are incorporated herein by this reference.

When the petition was filed in the instant case, petitioner was an Ohio estate with a legal residence in Cincinnati, Ohio. Decedent died a resident of Ohio on October 9, 1984. Decedent's estate was probated in Hamilton County, Ohio.

At her death decedent owned 168,600 voting shares of Jung Corp., which represented 20.83 percent of the outstanding voting shares and 20.74 percent of all the outstanding shares of Jung Corp.³

In the early 1900's decedent's husband cofounded Jung Arch Brace Co., the predecessor to Jung Corp. In 1949, a year after decedent's husband died, Jung Corp. was incorporated in Ohio as Jung Products, Inc. As of January 1, 1982, the name was changed to Jung Corp. Jung Corp.'s principal place of business was in Cincinnati, Ohio.

[101 T.C. 414]

On October 9, 1984, Jung Corp. owned all of the outstanding stock of the following companies: Jung International, Inc. (hereinafter sometimes referred to as JII), J.R.A. Industries, Inc. (hereinafter sometimes referred to as JRA), Rampon Products (hereinafter sometimes referred to as Rampon), Ione Realty (hereinafter sometimes referred to as Ione), and Calley & Currier; Jung Corp. also owned 96.3 percent of the stock of Theradyne.

Jung Corp. and its subsidiaries were primarily operating companies, except that Ione was a holding company for the real estate occupied by the operating companies. Jung Corp. consisted of two divisions—(1) the corporate division, which provided management services to the Jung Corp. subsidiaries, and (2) the Futuro division (hereinafter sometimes referred to as Futuro), which manufactured and marketed health care products and other products, including the products of Jung Corp. subsidiaries.⁴ Jung Corp. and its subsidiaries together comprised an integrated manufacturer and distributor of elastic textile goods and products, including elastic braces and supports, support stockings, and thermo comforters (elastic gloves and braces knitted with wool, which provide warmth and compression to swollen joints).

Futuro marketed health supports (such as elastic braces, athletic supporters, support socks and stockings, and hernia belts), patient aids (such as wheelchairs, canes, crutches, walkers, bed pans, and sitz baths), and thermo comforters. Futuro products were marketed almost entirely through drugstores, both nationally and internationally. About 95 percent of the health supports and 70–75 percent of the patient aids that Futuro marketed were manufactured by Jung Corp. and its subsidiaries. Futuro also marketed sporting goods through its All American and Grid lines. Futuro was Jung Corp.'s most profitable business. Futuro's health supports products were number one or number two in drug stores.

JII, incorporated in 1968, was the export sales agent for Jung Corp. products. JII bought goods for resale only from Jung Corp. or its subsidiaries. JII was a domestic international sales corporation (DISC) until December 31, 1984, at

[101 T.C. 415]

which time the DISC was liquidated and its successor was incorporated as a foreign sales corporation (FSC).

JRA, incorporated in 1969, primarily produced coarse yarns for sale to other Jung Corp. subsidiaries and to third parties. JRA also used the yarns to make elastic webbing, and it made fine elastic yarn from which Rampon (acquired by Jung Corp. in 1965) and third parties made stockings. In 1983 JRA acquired the property, plant, and equipment of a yarn covering operation in Raeford, North Carolina, and the Raeford operations became part of JRA. The industry in which JRA competed is very capital-intensive and has very low profit margins. JRA had a low profit margin in 1984.

Rampon produced knitted products including hosiery.

Theradyne manufactured wheelchairs for sale to Jung Corp. subsidiaries and to third parties. Jung Corp. acquired 70 percent of Theradyne's stock in 1973. Most of the remaining stock was held by Jung family members. In 1983 Jung Corp. acquired most of the rest of Theradyne in a stock-for-stock transaction. On October 9, 1984, Jung Corp. held 96.3 percent of Theradyne's stock. In 1984 Theradyne was either marginally profitable or losing money.

Jung Corp. acquired Calley & Currier in March 1984. Calley & Currier principally manufactured wooden crutches; it was the second largest wooden crutch manufacturer, with about one-third of the domestic market.

Ione was incorporated in 1949 by Jung family members and was transferred to Jung Corp. in 1973. Its primary purpose was to hold real and personal property which was used by Jung Corp.'s operating subsidiaries. Ione owned the manufacturing facility that Futuro occupied, the plant that Theradyne occupied, and the Richard Grey plant (which was a part of Rampon). Ione also owned a condominium in Florida. Ione charged rent for the facilities it owned, but the rent charged was not market value.

[101 T.C. 416]

Jung Corp. had industrial revenue bond (hereinafter referred to as IRB) financing for Futuro's manufacturing site. As of October 9, 1984, the outstanding balance of Jung Corp.'s IRB loan for Futuro was $970,000. JRA also had IRB financing. As of October 9, 1984, the outstanding balance of JRA's IRB loan was $3,030,000. The interest rate on JRA's IRB loan was computed at 69 percent of the current prime rate at the time of payment.

Jung Corp. kept its books and records on a calendar year basis. Jung Corp. and its subsidiaries filed consolidated tax returns. The net income after taxes of Jung Corp. and its subsidiaries for 1970 through 1979 is shown in table 1:

+-------+
                ¦Table 1¦
                +-------¦
                ¦ ¦ ¦
                +-------+
                

Year Net Income
                1970 $1,039,000
                1971 379,000
                1972 755,000
                1973 1,009,000
                1974 720,000
                1975 805,000
                1976 973,000
                1977 1,477,000
                1978 1,205,000
                1979 1,344,000
                

The audited financial statements for 1980 through 1986 show net sales and net income after taxes for the consolidated operations of Jung Corp. in the rounded amounts set forth in table 2:

+--------+
                ¦Table 2 ¦
                +--------¦
                ¦ ¦ ¦ ¦
                +--------+
                

Year Net Sales Net Income
                1980 $41,939,000 $1,233,000
                1981 46,352,000 944,000
                1982 48,800,000 1,739,000
                1983 62,757,000 1,889,000
                1984 67,918,000 3,123,000
                1985 71,606,000 2,098,000
                1986 54,679,000 1,991,000
                

The unaudited interim financial statement for September 30, 1984 (9 days before decedent's death), shows year-to-date net sales (rounded) of $52,271,000, and year-to-date net income after taxes (rounded) of $2,192,000. A portion of Jung Corp.'s unaudited interim consolidated balance sheet for September 30, 1984, is attached as Appendix A. Complete information concerning 1984 year-end adjusting entries is not available. However, for 1984 Jung Corp. made at least three year-end adjustments as follows: (1) The inventory of Theradyne was decreased by $426,677, most of which was because of the discontinuance of the Titann wheelchair line,

[101 T.C. 417]

(2) the inventory of Futuro was increased by an unknown amount to account for the increased costing of freight, and (3) deferred Federal income tax was decreased by $541,000.

Jung Corp. paid dividends of 4 cents per share from 1979 through 1983; in 1984 it paid dividends of 25 cents per share.

In November 1984 Jung Corp. employed 1,025 people.

In the early 1980's, Jung Corp. developed and installed computer programs which controlled its manufacturing and operating systems and produced financial statements, invoices, etc.

In the 1980's, governmental policies were introduced which were designed to reduce Medicare costs by discouraging hospital stays and encouraging home health care. Because Jung Corp. marketed its products primarily through drugstores rather than through hospitals, Jung Corp. stood to benefit from this trend. Almost all the products in Jung Corp.'s product lines would benefit from an increase in home health care expenditures.

Jung Corp. had formulated 5–year business forecast plans since 1975, but the emphasis was only on sales projections. In 1984 Jung Corp. began an in-depth analysis of its strengths, weaknesses, and opportunities, and it began to formulate specific business strategies. By mid–1984 Jung Corp. began to implement these strategies. Also, in 1984 Jung Corp. began involving employees in the planning and forecasting process. In mid–1984, to help with financial planning, Jung Corp. hired Jim Cox, a partner from Ernst & Whinney, and retained the services of an accounting firm. Jung Corp. decided to actively promote future growth through expanded domestic sales, and through acquisitions of other companies. It decided that Jung Corp. would become global in both sales and purchases, and it began searching for European companies to acquire. During 1984 Jung Corp. introduced additional products into the home health care market, and improved its then-current products. Beginning in 1984, each of Jung Corp.'s subsidiaries added a medical-surgical distribution service in order to provide products to surgical supply dealers, hospitals, and...