Estate of McDonald v. U.S.
| Decision Date | 30 December 2003 |
| Docket Number | No. CIV.A. 02-AR-1765-S.,CIV.A. 02-AR-1765-S. |
| Citation | 302 F.Supp.2d 1285 |
| Parties | ESTATE OF Peggy Spain MCDONALD, Amsouth Bank as Executor, Plaintiff v. UNITED STATES of America, Defendant |
| Court | U.S. District Court — Northern District of Alabama |
Samuel H. Frazier, Mark W. Macoy, Spain & Gillon LLC, Birmingham, AL, for plaintiff.
Alice H. Martin, US Attorney, US Attorney's Office, Birmingham, AL, Hemant Sharma, US Department of Justice, Washington, DC, for defendant.
Before the court are cross motions for summary judgment. The first is by defendant, United States of America ("Government"). The second is by plaintiff, the Estate of Peggy Spain McDonald, deceased, ("Estate"). The Internal Revenue Service ("IRS") audited the Estate and determined that $504,723.08 in additional tax was owed. The IRS contends that Alabama law precluded certain actions taken before and after the testatrix's death and that the Estate had incorrectly calculated its charitable deduction. The Estate paid the amount of the alleged additional tax, plus interest, and, after further proceedings in the state probate court, seeks in this court a refund in the amount of $364,115.13, plus interest.1 This court has jurisdiction pursuant to 28 U.S.C. § 1346(a)(1).
Peggy Spain McDonald ("Peggy") died on April 28, 1996. Her will, executed on August 21, 1986, devised personal property to certain individuals and established a family trust for the benefit of her grandchildren and their descendants with 7/8 of the residue estate. Her beneficiaries were unaware of the specifics of the will until after her death.
In a codicil dated October 23, 1987, Peggy directed the trustee to divide the grandchildrens' family trust in two. A $1 million generation-skipping transfer ("GST") exemption was allocated to one trust. The other trust would be subject to the GST tax. A second codicil, dated December 9, 1988, added the following provisions to "Item II" of the will:
(f) I hereby forgive any debt owed to me by any child of mine and direct that such debt need not be paid to my estate.
(g) I give and bequeath all shares of the stock of Tour Golf, Inc., owned by me at the time of my death, to my son, William McDonald, to be his absolutely.
A third codicil, dated April 17, 1991, and a fourth codicil, dated May 22, 1991, further revised Item II, but repeated provisions (f) and (g) without change.
On May 22, 1991, the same day upon which Peggy executed the fourth codicil, she also executed a durable power of attorney ("1991 DPOA"). Under the 1991 DPOA, Peggy's daughter, Cameron McDonald Vowell ("Cameron"), and Peggy's son, William McDonald ("William"), were jointly named as attorneys-in-fact. The 1991 DPOA took effect on February 7 1994, when Peggy's physicians certified in writing that she was incapacitated. However, Cameron acted alone as Peggy's attorney-in-fact because William formally declined the appointment.
At the time of her death, Peggy owned 40% of the stock of a subchapter S corporation, Tour Golf Shops Limited, Inc. ("Tour Golf"); William, owned 20%, and his wife, Nancy McDonald, owned the remaining 40%. William was the president and principal operating agent of Tour Golf. Tour Golf initially operated sporting-goods stores. It purchased a driving range and opened a golf school around 1992. It was never profitable, and as of October 1995, its primary asset was real property used as a driving range (the "Valleydale Property").
On October 12, 1995, Tour Golf entered into a purchase option with Tynes Development Corporation ("Tynes") by which the Valleydale Property would be sold for $1.6 million upon its being rezoned R-5 for multifamily use. The contract was amended on November 21, 1995 to allow Tynes to purchase the property for $1.2 million if rezoned to a lower density R-4 use. The $0.4 million difference in the sales price was significant because AmSouth Bank, N.A. ("AmSouth") held more than $1.4 million in notes receivable against Tour Golf. The AmSouth notes were partially secured by a $650,000 mortgage on the Valleydale Property.
On December 1, 1995, Peggy, acting through Cameron, as attorney-in-fact, purchased the Tour Golf notes from AmSouth. Peggy thereupon became the creditor of Tour Golf, partially secured by the Valleydale Property and the guarantee. The debt was consolidated, and Tour Golf's payments were rescheduled and restructured pursuant to an Amended and Restated Note. In exchange, Tour Golf executed a second mortgage on the Valleydale Property to secure the amended note in the amount of $840,699.73 payable to Peggy. This increase in the secured obligation was accompanied by personal guarantees from William and Nancy.
Tour Golf's attempts to have the Valleydale Property rezoned failed. It continued to make payments to Peggy in accordance with the amended note until selling the property on February 20, 1997, after Peggy's death. The sale netted Tour Golf $848,545.38. Upon Peggy's death, William owned 60% and Nancy the remaining 40% of Tour Golf because the will bequeathed Peggy's 40% share to William. William and Nancy received all the proceeds from the sale. They dissolved Tour Golf on September 10, 1998, about a year after Peggy's death.
On December 7, 2001, the Probate Court of Jefferson County, Alabama found that Peggy's will expressed a clear intent to forgive all debts owed to her estate by Tour Golf. Likewise, the court found that Peggy intended the 1991 DPOA to grant joint and several power to Cameron and/or William. The court concluded that the purchase of the debt was proper and ordered forgiveness of Tour Golf's consolidated debt under Item II(f) of Peggy's will. In addition, William and Nancy were ordered to pay the proceeds of $848,545.38 from the sale of the Valleydale Property to the Estate to prevent any unjust enrichment.
On January 28, 1997, the Estate timely filed its federal tax return. The Estate timely paid $2,363,871.85 in estate and GST taxes with the return. Forgiveness of the Tour Golf debt was treated as a devise to William under the will. Therefore, although the Tour Golf debt, $1,433,155.90, was included as an asset of Peggy's Estate for estate-tax purposes, the debt was not included in computing the value of the residuary estate subject to the GST tax. Additionally, the return assigned all of the tax burden to the family trust instead of to the charitable trust created by the will. This had the effect of decreasing the value of the residuary estate subject to the GST tax.
Around November 20, 1997, the IRS served an audit letter on the Estate and assigned an examiner, Suzanne Paulson. Paulson concluded that the Tour Golf debt was not forgiven under Peggy's Will or, in the alternative, that Cameron exceeded her authority under the 1991 DPOA when she purchased, on behalf of Peggy, the notes receivable from AmSouth. She also concluded that (1) the charitable trust should bear its pro rata portion of the taxes, and (2) that the assets in Peggy's November 9, 1977 revocable trust should have been included in computing the value of Peggy's estate subject to the GST tax. Accordingly, the IRS assessed additional estate and GST taxes in the amount of $504,723.08, plus interest in the amount of $187,721.91 through December 15, 1999. The Estate timely paid this additional alleged amount without conceding that the Government was correct.
On December 12, 2001, after the probate court's decision that the Tour Golf debt could be purchased under the DPOA and discharged under Peggy's will, the Estate filed a refund claim. The IRS took no action on the claim. The Estate then timely filed this lawsuit challenging the IRS audit as erroneous. It seeks a refund pursuant to 26 U.S.C. § 7422 in the amount of $364,115.13, plus interest and attorneys' fees.
The Estate argues that the IRS incorrectly determined that: (1) Cameron's decision, as Peggy's attorney-in-fact, to purchase the Tour Golf debt from AmSouth was invalid; (2) Item II(f) of Peggy's will cannot operate to forgive the debt of Tour Golf; and (3) property qualifying for the charitable deduction must be reduced by its pro rata share of the gross estate taxes. Like a plaintiff in any civil action in district court, the taxpayer bears the burden in a tax-refund case of proving by a preponderance of the evidence the claim as to liability and amount. United States v. Janis, 428 U.S. 433, 440, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1976); United States v. Harris, 216 F.2d 690, 691 (5th Cir.1954); see also 1997 Fed. Tax Coordinator 2d (RIA) ¶ U-4707. The Estate relies on the probate court's December 7, 2001 order to meet its burden in this court.
Federal courts are not bound by a state probate court's determination as to the character of a property interest "where the federal estate tax liability turns upon" that characterization. Comm'r of Internal Revenue v. Estate of Bosch, 387 U.S. 456, 457, 87 S.Ct. 1776, 18 L.Ed.2d 886 (1967). Nor can the state court's decision have the effect of res judicata when the government was not a party to the state court proceeding. Id. at 463, 87 S.Ct. 1776. However, the state court decision is entitled to "proper regard" when the underlying substantive rule involved is based on state law and when there is no decision on point by the highest court in that state. Id. at 465, 87 S.Ct. 1776; see also Miglionico v. United States, 323 F.Supp. 197, 200 (N.D.Ala.1971); Estate of O'Neal v. United States, 81 F.Supp.2d 1205, 1271-18 (N.D.Ala.1999), aff'd in part, vacated in part, 258 F.3d 1265 (11th Cir.2001).
In Estate of Salter v. Comm'r, 545 F.2d 494 (5th Cir.1977), the former Fifth Circuit2 held that "[i]n the absence of a case specifically on point, the best measure of the `[proper] regard,' we think, would be to determine, from existing precedent, in our best judgment, whether the [state] Supreme Court ... would have affirmed the [lower court's...
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...was not filed until almost three years after the time limited prescribed by I.R.C. § 6511(a).2. Estate of McDonald v. United States, 302 F. Supp 2d 1285 (N.D. Ala. 2003)At the time of death, the decedent owned stock in a sub-chapter S corporation that owned and operated a driving range and ......