Davis v. United States

• Decision Date: 20 November 1969
• Docket Number: Civ. No. 69-417-AAH.
• Citation: 306 F. Supp. 949
• Court: U.S. District Court — Central District of California
• Parties: Robert C. DAVIS, as surviving joint tenant and statutory Executor of the Estate of Isabelle Mildred Davis, deceased, Plaintiff, v. UNITED STATES, Defendant.

306 F. Supp. 949

Robert C. DAVIS, as surviving joint tenant and statutory Executor of the Estate of Isabelle Mildred Davis, deceased, Plaintiff, v. UNITED STATES, Defendant.

Civ. No. 69-417-AAH.

United States District Court C. D. California.

November 20, 1969.

Clarke & Swink by Dickinson Thatcher, North Hollywood, Cal., for plaintiff.

Wm. Matthew Byrne, Jr., U. S. Atty., Charles H. Magnuson, Mason C. Lewis, Asst. U. S. Attys., Los Angeles, Cal., for defendant.

HAUK, District Judge.

Non-jury trial has been concluded in this civil action against the United States for the recovery of estate taxes alleged to have been erroneously and illegally collected, jurisdiction existing by virtue of 28 U.S.C. § 1346 (1962).¹ The Court, having heard full arguments and having considered the points and authorities submitted by counsel for both parties, now renders its decision.

At the time of the death of Decedent, Isabelle Mildred Davis on March 29, 1965, she and her husband held joint tenancy ownership in a modest accumulation of property. On June 23, 1966, the husband, as surviving joint tenant and statutory executor of his wife's estate, filed an Estate Tax Return Form 706 which, as part of the assets of the estate held in joint tenancy, listed 9,518 shares of Affiliated Fund, Inc., an open-end investment company.

The capital stock of Affiliated Fund, Inc. is offered by the investment company to the public at a price per share determined twice daily and based upon the total market value of the portfolio securities owned by the Fund. The actual offering price to the general public is the net asset value per share, plus a sales commission which is a varying percentage of the offering price, dependant upon the quantity of shares purchased in a single transaction, and ranging from 2½% on sales of $100,000 or more to 7½% on sales of $5,000 or less.

The charter of Affiliated Fund, Inc. guarantees stockholders the right to have their shares of stock redeemed or repurchased by the company at the net asset value per share of the portfolio securities owned by the Fund, based upon closing market prices on the day the stock certificates are surrendered to the company. Plaintiff and defendant here have stipulated that in the normal course of business no portion of the 9,518 shares of Affiliated Fund, Inc. in Decedent's estate would or could have been sold except by way of sale to the company at this redemption or repurchase price guaranteed by its charter.

On the Estate Tax Return the 9,518 shares of Affiliated Fund, Inc. were valued at the redemption price of $9.06, or a total of $86,233.08. On April 25, 1968, the Government sent its 90-day letter to the Estate, assessing a tax deficiency computed by adjusting upwards the valuation of the 9,518 shares upon the theory that the shares should have been valued at the "offering price to the public", rather than at the "redemption price", and upon the determination that the last "public offering price" on the date of Decedent's death, March 29, 1965, for this number of shares was $9.43 per share or a total of $89,754.74 as compared with the redemption price of $9.06 per share or a total of $86,233.08.

The deficiency assessed by the Internal Revenue Service was paid, and on October 11, 1968, plaintiff filed a claim for a refund which was denied. Thereupon, having complied with the prerequisites of 26 U.S.C. 7422 (1967),² plaintiff, as surviving joint tenant and statutory executor of the Estate, filed this civil action for refund of taxes and interest erroneously and illegally collected.

The sole issue to be decided is the validity of Treas.Reg. § 20.2031-8 (b) (1963),³ pursuant to which the Internal Revenue Service values the shares of open-end investment companies at their offering price to the public rather than at their redemption price. We conclude that the Treasury Regulation is invalid, that the 9,518 shares of Affiliated Fund, Inc. should have been valued for estate tax purposes at their redemption price and not at their offering price to the public, and that pursuant to stipulation of the parties, plaintiff is entitled to recover from defendant the principal sum of $523.53 together with interest on $190.41 from June 23, 1966, interest on $232.44 from May 16, 1967, and interest on $100.68 from September 24, 1968, all at the rate of 6% per annum, together with plaintiff's costs of suit incurred herein.

The gross estate for estate tax purposes is defined by Congress in Int.Rev. Code of 1954, § 2031(a), 26 U.S.C. § 2031 (a) (1967): "The value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated." Provisions similar to § 2031(a) defining the gross estate have appeared in the Revenue Acts since 1916.⁴

Pursuant to Int.Rev.Code of 1954, § 7805(a),⁵ 26 U.S.C. § 7805(a) (1967), it is clear that the Secretary of the Treasury and his delegate have authority to prescribe all needed rules and regulations for the enforcement of the Internal Revenue Code. Furthermore, it is clear "that Treasury Regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes and that they constitute contemporaneous constructions by those charged with administration of these statutes which should not be overruled except for weighty reasons." Commissioner of Internal Revenue v. South Texas Lumber Co., 333 U.S. 496, 501, 68 S.Ct. 695, 698, 92 L.Ed. 831 (1948). Regulation 20.2031-8(b) (1963), which is directly involved in this case and under which the Internal Revenue Service valued the 9,518 shares of the Fund at their offering price to the public, did not become effective until 1963 and then only after October 10, 1963. Prior to this Regulation there was no clear rule of valuation or specific definition of value for estate tax purposes of the shares of an open-end investment company.⁶ But since the statutory definition of value had been in the Revenue Acts since 1916, it is obvious that this Regulation cannot in any sense be deemed a contemporaneous construction of the statute, and since it did not apply until October 10, 1963, it is by no means a long standing Regulation entitled to the judicial respect that longevity sometimes merits. No wonder it has generated the adverse reaction and criticism of the American Bar Association's Taxation Section,⁷ a Congressional Bill to amend the Internal Revenue Code to require redemption price valuation,⁸ and a rash of lawsuits throughout the country.⁹

That other Federal Courts should not have any greater difficulty than we do in overturning Regulation 20.2031-8(b) is indicated by recent tax cases which have invalidated the arbitrary and discriminatory regulations imposed upon personal service corporations.¹⁰

Every attempt by the Internal Revenue Service to enforce the new regulations dealing with personal service corporations has been vigorously rebuffed by the courts. In the words of the most recent case, Kurzner v. United States, 413 F.2d 97, 106 (5th Cir., 1969):

"Since the adoption of the 1965 amendments, the IRS has attempted in a number of cases to enforce the new rules. The judicial response has been unanimous: the courts have invalidated the amended regulations as being arbitrary and discriminatory legislation by an administrative agency which is only authorized to interpret congressional acts."

See also, O'Neill v. United States, 410 F.2d 888 (6th Cir., 1969); and United States v. Empey, 406 F.2d 157 (10th Cir., 1969).

The basic rule for determining the "value" of property includible in the decedent's gross estate for estate tax purposes under Int.Rev.Code of 1954, §§ 2031 to 2044, is contained in Treasury Regulation 20.2031-1(b), T.D. 6826, 1 Fed.Est. & Gift Tax Rep. ¶ 1200 at 961, which provides that "value" generally means the fair market value at the date of decedent's death or upon the date prescribed by the alternate valuation method under Int.Rev.Code of 1954, § 2032. The Regulation describes the fair market value as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."

The general valuation rules must be read in conjunction with the rules governing specific items of property. Reg. 20.2031-3 (1958) applies to the valuation of an interest in a business and specifically describes relevant factors to be used in determining the fair market value. Reg. 20.2031-2 (1958) applies the fair market value rule to stocks and bonds. If there is a market for the stocks and bonds the "mean between the highest and lowest quoted selling prices on the valuation date is the fair market value per share or bond", but where no selling prices or bid and asked prices are available, the Regulation specifies relevant factors to consider, such as the "soundness of the security", the "economic outlook in the particular industry", and "the company's position in the industry". Reg. 20.2031-8(a), T.D. 6680, 1 Fed.Est. & Gift Tax Rep. ¶ 1211 at 1402, covers the valuation of certain life insurance and annuity contracts and specifies the value to be the price at which "a company regularly engaged in the selling of contracts of that character" sells a "comparable contract". All of these regulations obviously attempt to apply the general valuation rule of fair market value to these particular types of property and thus attempt realistically to reflect the true actual value of the property to the estate of the decedent.

But Regulation 20.2031-8(b) (1963), specifically covering the valuation of shares in an open-end investment company, provides that "The fair market value of a share in an open-end investment company (commonly known as a `mutual fund') is the public offering price of a share, adjusted for any reduction in...