Estate of Gloeckner v. C.I.R., Docket No. 97-4007

• Decision Date: 18 August 1998
• Docket Number: Docket No. 97-4007
• Citation: 152 F.3d 208
• Parties: -5748 ESTATE OF Frederick Carl GLOECKNER, Deceased, Joseph A. Simone, Executor and Douglas Dillon, Executor, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

Page 208

152 F.3d 208

82 A.F.T.R.2d 98-5748

ESTATE OF Frederick Carl GLOECKNER, Deceased, Joseph A.

Simone, Executor and Douglas Dillon, Executor, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Docket No. 97-4007.

United States Court of Appeals, Second Circuit.

Argued Dec. 15, 1997.

Decided Aug. 18, 1998.

James E. Daniels, New York, New York (Landis Olesker, Steven D. Goldberg, Hara K. Jacobs, Hall Dickler Kent Friedman & Wood LLP, New York, New York, of counsel), for Petitioners-Appellants.

Curtis C. Pett, Washington, D.C. (Teresa E. McLaughlin, Tax Division, Loretta C. Argrett, Assistant Attorney General, Department of Justice, Washington, D.C., of counsel), for Respondent-Appellee.

Before: OAKES, CARDAMONE, and CALABRESI, Circuit Judges.

CARDAMONE, Circuit Judge:

This appeal is brought by petitioners, who are the executors of the estate of Frederick Carl Gloeckner. The Commissioner of Internal Revenue, in reviewing the estate tax return for decedent Gloeckner, assigned a greater value than that which was claimed for shares of stock Gloeckner owned in a closely-held corporation he had founded. Petitioners reported the value of these shares to be the value set forth in a redemption agreement between decedent and his company. The Commissioner disagreed and instead Upon receiving the notice of deficiency dated April 19, 1994, petitioners appealed to the United States Tax Court (Halpern, J.), arguing that the redemption agreement complied with the terms of a Treasury regulation allowing these kinds of agreements to determine the value of securities for estate tax purposes once certain prerequisites are met. In an order entered on October 16, 1996 the tax court agreed with the Commissioner that the agreement did not apply to fix the value of the stock, but thought that value was less than the amount the Commissioner had asserted. The tax court assessed a tax deficiency in the reduced amount of $561,077.79.

assessed a tax deficiency of $2,951,936.96.

The key issue in this case is the interpretation of the relevant Treasury regulation. Our analysis requires us to resolve whether the beneficiary of the redemption agreement was the natural object of decedent's bounty, a somewhat elusive concept not admitting of one clear definition that would apply to all cases, but rather one best decided on a case-by-case basis. After examining the regulation's language and case law construing it, we think the tax court misapplied the regulation and that the value of the stock fixed in Gloeckner's redemption agreement should control. We therefore reverse and remand this matter for entry of judgment for the estate.

BACKGROUND

A. Facts

Gloeckner died on July 28, 1990 at the age of 88. Having never married, he left surviving as kin, a niece, nephew, grandniece and grandnephew. In 1934 he had founded Fred C. Gloeckner & Co., a New York corporation that distributed plants, bulbs and other horticultural products to commercial growers at wholesale prices. Decedent remained a shareholder and president of his company until his death.

Gustav Poesch became a shareholder in decedent's company in 1949 and ultimately served on its Board of Directors as its vice president. Gloeckner and Poesch signed a redemption agreement in 1960 restricting their rights to dispose of their stock in the company. By mid-1987 Gloeckner then aged 85 and Poesch aged 77 began to make new plans for the future of the company and the disposition of their stock. Gloeckner owned the majority of stock, Poesch held a minority interest, and the remainder belonged to the Fred C. Gloeckner Foundation.

Gloeckner wanted Joseph Simone, an unrelated company officer in his mid-30s, to own and manage the company after his death. Simone had begun working for the company in 1975, was elected its secretary in 1981, and was named to its Board of Directors as secretary/assistant treasurer several years later. Decedent had befriended the younger man to such extent that he gave Simone an interest-free loan of $80,000 in 1981, and another loan of $95,000 five years later, this time repayable with interest. These loans were secured by a mortgage on Simone's house. Other employees apparently received similar loans from decedent. Simone testified that he and Gloeckner shared a professional, but not social, relationship.

The critical year for purposes of this appeal is 1987. In accordance with Gloeckner's and Poesch's proposed plans, they along with Simone met with Gloeckner's attorney on June 11 of that year. During the meeting they discussed Poesch's intended charitable contribution of his preferred stock, redemption of his common stock by the company upon his death to allow his estate to pay the taxes attributable to that stock, and his bequest of any remaining common stock to Simone. Decedent also agreed to make an inter vivos gift of 20 shares of his common stock to Simone.

Meanwhile, Gloeckner's attorney was preparing a new will and corporate redemption agreement for decedent to sign. The redemption agreement provided that the corporation would buy as much stock upon Gloeckner's death as necessary to pay his estate taxes. This plan permitted Gloeckner's kin to receive a substantial majority of his estate by operation of his will-- excluding his stock, and thereby any control, in the company--free from erosion for taxes or expenses.

Gloeckner signed the redemption agreement on July 10, 1987. Beyond requiring the company to purchase enough stock to cover the estate tax liability (beginning with the common stock and then purchasing preferred stock, if necessary), the agreement also restricted decedent's ability to sell or transfer his shares during his lifetime, granted the company first option to purchase his shares if he chose to sell them during his lifetime, and gave the company the option to purchase any remaining shares not redeemed to pay Gloeckner's estate taxes at the time of his death. The purchase price for each share was left blank in the redemption agreement, to be filled in after an appraisal could be made. Gloeckner's will bequeathed to Simone any common stock not repurchased by the corporation either for tax purposes or at its option.

Decedent also made the planned gift of 20 shares to Simone on July 10, 1987. That same day, Simone signed a restrictive agreement containing the same terms as those found within Gloeckner's agreement. Again, the purchase price was left blank until the appraisal was complete.

The company retained KPMG Benchmark to determine the fair market value of Gloeckner's shares of stock as of June 30, 1987. KPMG Benchmark reported on October 30, 1987 that the common stock was worth $440 per share, and the two classes of preferred stock were worth $34.75 and $48 respectively. These calculations were based upon numerous factors, including past transactions, marketability of the shares, investment quality of the shares, balance sheet figures (assets, liabilities and book value of the company), historical operating results, dividends paid historically, and dividend-paying capacity. Appraisers not only interviewed and corresponded with company management and other advisors to learn more about the company, but also reviewed the bases of investors' appraisals of publicly-traded shares of comparable companies at the valuation date. These figures were entered into Gloeckner's redemption agreement accordingly. The price of $290 per share entered into Simone's redemption agreement likewise originated from the KPMG Benchmark report.

Decedent signed his will on July 22, 1987, in which he bequeathed $40,000 to his "friend" Simone, along with any remaining common stock owned by him after the redemption agreement took effect. His kin were to receive the remainder of his estate less charitable contributions, including one giving all remaining preferred stock to the Fred C. Gloeckner Foundation.

Poesch, instead, contrary to the June 11 discussions, never entered into a new redemption agreement. The record does not indicate why. However, he did sell his shares of common stock back to the company on January 4, 1988 at the price listed in the agreement of $290 per share. That price, the same as that assigned to Simone's minority shares, came out of the KPMG Benchmark report. After this sale, Poesch remained a member of the Board of Directors. He died before these proceedings began in tax court.

When Gloeckner died, three years after signing the redemption agreement, the company had to buy all his shares to cover the estate taxes owed. Despite decedent's intent to spare his kin the burden of paying any estate tax out of their inheritance, the proceeds from the stock redemption were insufficient to cover the amount due, so that they were required to pay tax and administrative expenses of about $1 million.

B. Tax Court Proceedings

When they filed the estate tax return, petitioners listed the value of Gloeckner's stock at $2,298,161.25--which was equal to the redemption price and the amount paid by the company. In assessing a tax deficiency, the Commissioner placed a value of $6 million on the shares. That action prompted the estate to commence the instant litigation in May 1994.

Trial was set for February 21, 1995. Under tax court Rule 143(f), each party was to submit expert reports 30 days in advance of trial, i.e., January 20, 1995. The Commissioner filed and served a report on January 20. Petitioners told the court on January 27 and in writing on January 31 that they would use the 1987 KPMG Benchmark appraisal The Commissioner filed a motion in limine, asking that petitioners' reports be excluded because they were not timely filed. The tax court granted the motion. Trial was held February 28 and March 1, 1995. Petitioners called Simone and Gloeckner's attorney as witnesses, and also introduced the 1987 report, not as an expert report, but rather as evidence that an appraisal was obtained. The Commissioner called...