Estate of Hudgins v. C.I.R., 94-40211

• Decision Date: 28 June 1995
• Docket Number: No. 94-40211,94-40211
• Citation: 57 F.3d 1393
• Parties: -5401, 64 USLW 2044, 95-2 USTC P 60,202 ESTATE OF Harry M. HUDGINS, Deceased, Lee C. Hudgins and Harry Hudgins II, Co-Independent Executors, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1393

57 F.3d 1393

76 A.F.T.R.2d 95-5401, 64 USLW 2044,

95-2 USTC P 60,202

ESTATE OF Harry M. HUDGINS, Deceased, Lee C. Hudgins and

Harry Hudgins II, Co-Independent Executors, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 94-40211.

United States Court of Appeals, Fifth Circuit.

June 28, 1995.

Rehearing Denied Sept. 5, 1995.

David L. Jordan, Acting Chief Counsel/Curtis G. Wilson, I.R.S., Teresa E. McLaughlin, Gary R. Allen, Chief, Kevin M. Brown, Atty., and Ann A. Durney, Appellate Section, Tax Div., Dept. of Justice, Washington, DC, for appellant.

William D. Elliott, Cowles & Thompson, Dallas, TX, for appellees.

Appeal from the Decision of the United States Tax Court.

Before JOLLY and WIENER, Circuit Judges. ^*

WIENER, Circuit Judge.

In this federal estate tax case, implicating "special use valuation" of several tracts of farm or ranch property owned by Harry M. Hudgins (Decedent) at the time of his death, the Commissioner of Internal Revenue (Commissioner) appeals the adverse decision of the United States Tax Court (Tax Court). The Commissioner questions the Tax Court's holding that, when filing Decedent's federal estate tax return (706), the independent co-executors of Decedent's estate (Estate) "substantially complied" with the requirements of the Internal Revenue Code (Code) and applicable Treasury Regulations (Regs.) for electing a special use valuation of the Estate property, thereby entitling the Estate to perfect its election within ninety days following notice from the IRS that the Estate's election was defective. Concluding that the Tax Court's substantial compliance ruling was erroneous, we reverse and remand for further proceedings consistent with this opinion.

I FACTS AND PROCEEDINGS

Decedent was a Texas rancher who died testate in 1987. ¹ In his Last Will and Testament (the Will), Decedent left several tracts of ranch property to various combinations of five grandsons. The Will's SECTION 5., which applied to each legacy of ranch property that resulted in two or more of Decedent's grandsons becoming "joint owners," imposed several ten year restrictions on the legatees and the property thus bequeathed: (1) No such jointly owned tract could be mortgaged or partitioned; (2) any joint owner of an interest in one tract could sell his interest to another joint owner of that tract but not to any other person; and (3) any joint owner could rent or lease his interest to another joint owner but not to any other person. [Neither SECTION 5. nor any other provision of the Will expressly required that the land actively be used for ranch purposes, expressly prohibited any other use of the property, expressly required the grandsons to participate in qualifying activities, or expressly imposed any penalties, such as reversion, revocation, forfeiture or other loss of ownership interests, in the event of an actual The Will appointed Decedent's son, Lee C. Hudgins, grandson, Harry Hudgins II, and long-time attorney and scrivener of the Will, Joe A. Keith, to serve as Independent Co-Executors (Executors). The Will specified that Mr. Keith's service as a co-executor would not preclude his being compensated "for also being attorney for my estate." Although not expressed in the Will, Mr. Hudgins apparently expected the Estate to retain Mr. Keith as its attorney, which it did.

or attempted alienation in violation of the restriction.] ²

Mr. Keith was an experienced attorney who had represented Mr. Hudgins for over forty years, had also represented other prominent ranching families in that part of North Texas, and had prepared and filed a number of federal estate tax returns, including some in which special use valuation elections were made. The record reflects that Mr. Keith was incapacitated at the time this action was commenced in the Tax Court and has since died.

Mr. Keith prepared and timely filed the 706 for the Estate. In the portion of the 706 that asks if the estate intends to elect special use valuation on any of its property, the "Yes" box was checked. In compliance with instructions in the 706, the Estate completed and affixed a Schedule N, together with required attachments to that schedule. A "Notice of Election" was also attached to the 706, but it contained only nine of the fourteen items required by the instructions and the Regs. The Notice of Election contains a statement, presumably affixed by Mr. Keith, to the effect that "[i]t is considered that all requirements exist for special valuation of the qualified real property." Although the Notice of Election contains signature lines for all five grandsons, only three of the five had signed that instrument by the time it was filed with the 706. This is at least partially explained in a "Memorandum" typed at the bottom of the Notice of Election and signed by Mr. Keith, which states that one of the grandsons had not signed "because he is in military service" and that another had not signed because he was "not presently available." The Memorandum concludes with the following statement:

"To remedy that situation, the undersigned preparer of this Form 706 will undertake to obtain the signatures of [the two grandsons who had not signed] on a counterpart hereof, which when available will be transmitted to the office of the Internal Revenue Service at Austin, Texas."

The record does not reflect that any steps were taken to effectuate the promised "remedy" until after the IRS audited the 706 and notified the Estate that its special use valuation election was defective due to the incomplete Notice of Election and the failure to attach an executed Recapture Agreement.

Within ninety days after receiving that notice from the IRS, the Estate submitted all previously missing information, documentation, and signatures. The Commissioner nevertheless denied the special use valuation claimed by the Estate, contending that, as the Estate's initial election was not "in substantial compliance" with the requirements of the Regs., the Estate was precluded from perfecting its election post hoc. The Commissioner assessed the subject properties at their fair market values, thereby increasing the value of the gross estate by $487,790--the excess of the aggregate fair market value of the subject tracts over their aggregate special use valuations. ³ As a result of this adjustment the Commissioner issued a deficiency notice to the Estate for underpayment of taxes in the amount of $149,622.

The Estate petitioned the Tax Court for a redetermination of the deficiency. Following a trial on mostly stipulated facts, the Tax Court held that the Estate was indeed entitled to the special use valuation, thus there was no deficiency in estate taxes. The

court's conclusion that the Estate was entitled to special use valuation was grounded in its determination that the Estate's initial election substantially complied with the election requirements, entitling the Estate to perfect its election within the statutory period following notice of the defective election. This review followed the Commissioner's timely filing of a notice of appeal.

II

ANALYSIS

The Tax Court's holding for the Estate apparently served as a wake-up call for the Commissioner, for his brief to this court presents both a comprehensive explanation of the law applicable to special use valuation elections and an application of that legal framework to the pertinent facts. We therefore borrow extensively from the Commissioner's brief in the analysis that follows.

A. Standard of Review

In reviewing decisions of the Tax Court we apply the same standards used in reviewing a decision of the district court: Questions of law are reviewed de novo; findings of fact are reviewed for clear error. ⁴ We will not find a ruling to be clearly erroneous unless we are left with the definite and firm conviction that a mistake has been made. ⁵

In the instant case the discrete facts, as noted, are stipulated for the most part and otherwise are essentially undisputed. That the belated efforts of the Estate to perfect the election were substantively adequate is not disputed; thus the sole issue presented is whether the Estate's initial effort was sufficient to constitute "substantial compliance," thereby entitling the Estate to perfect its election within ninety days following notice from the IRS that the original election was defective. Even though the parties assumed that this issue presented a factual question, i.e., whether the facts of the case constitute "substantial compliance"--a term of art in Code Sec. 2032A(d)(3)--we believe that, despite the fact that in other contexts issues of substantial compliance, like substantial completion, are indeed questions of fact, the question here presented is one of law. Resolution of this fact/law dichotomy is not important in this appeal, however, as we conclude that, irrespective of whether we review the issue de novo or for clear error, the Tax Court erred reversibly in determining that the Estate's initial filing was in substantial compliance with the requirements for a valid special use election.

B. Special Use Valuation

Generally, property subject to federal estate tax is returned at its fair market value. ⁶ One limited exception to that generality is found in Sec. 2032A of the Code, which provides an alternative, more "taxpayer friendly" method for valuing some family farms and closely held businesses. ⁷ Courts have recognized that, in enacting Sec. 2032A, Congress sought to provide relief to those who, when inheriting family farms, might otherwise be forced to sell them to pay estate taxes calculated on "highest and best use" values, which often exceed significantly the land's value for farming purposes. ⁸ In the hope of avoiding such a result and helping to preserve family farms and other closely held businesses, Congress allows qualifying property to be returned for estate tax purposes at its actual (farm) use value rather than its fair ...