Estate of O'Neal v. U.S.

• Decision Date: 31 July 2002
• Docket Number: No. CV-97-J-2189-S.,CV-97-J-2189-S.
• Citation: 228 F.Supp.2d 1290
• Parties: ESTATE OF Elizabeth Paramore O'NEAL, deceased, Elizabeth O'Neal Shannon, Emmet O'Neal, II, and Emmet O'Neal, III, Personal Representatives, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Northern District of Alabama

228 F.Supp.2d 1290

ESTATE OF Elizabeth Paramore O'NEAL, deceased, Elizabeth O'Neal Shannon, Emmet O'Neal, II, and Emmet O'Neal, III, Personal Representatives, Plaintiffs, v. UNITED STATES of America, Defendant.

No. CV-97-J-2189-S.

United States District Court, N.D. Alabama, Southern Division.

July 31, 2002.

E. T. Brown, Jr., Roy J. Crawford, C. Fred Daniels, Sydney F. Frazier, Jr., Phillip B. Walker, Cabaniss, Johnston, Gardner, Dumas & O'Neal, Birmingham, AL, for Elizabeth Paramore O'Neal, Estate of, deceased, Elizabeth O'Neal Shannon, Personal Representative, Emmet O'Neal, II, Personal Representative, Emmet O'Neal, III, Personal Representative, plaintiffs.

Alice H. Martin, U.S. Attorney, U.S. Attorney's Office, Birmingham, AL, Lynne M. Murphy, Candice M. Turner, U.S. Department of Justice, Tax Division, Ben

Franklin Station, Washington, DC, for United States of America.

MEMORANDUM OPINION

JOHNSON, District Judge.

This case is before the Court on remand from the Court of Appeals for the Eleventh Circuit for further consideration consistent with its opinion in O'Neal v. United States, 258 F.3d 1265 (11th Cir.2001), affirming in part, vacating in part, and remanding with instructions this Court's decision reported at 81 F.Supp.2d 1205 (N.D.Ala.1999).

The central issue in this case involves the estate tax deduction by the Estate of Elizabeth P. O'Neal, deceased, ("Mrs. O'Neal's Estate") under 26 U.S.C. § 2053(a)(3) for claims against Mrs. O'Neal's Estate resulting from transferee gift tax and generation-skipping transfer tax liabilities asserted against the children and grandchildren of Elizabeth P. O'Neal ("Mrs. O'Neal") as donees of certain gifts made by Mrs. O'Neal. The Court of Appeals held that for purposes of the deduction, the claims are to be valued as of the date of Mrs. O'Neal's death without regarded to events occurring after her death and remanded this issue with instructions to conduct an evidentiary hearing to value the claims giving rise to the deduction as of the date of Mrs. O'Neal's death. 258 F.3d at 1266, 1275.

FINDINGS OF FACT

The opinion of the Court of Appeals and this Court's original memorandum opinion set forth in detail the facts concerning the gifts made by Mrs. O'Neal, the expiration of the statute of limitations for assessing gift tax, generation-skipping transfer tax and penalties against Mrs. O'Neal for the gifts to her children and grandchildren, and the assertion of transferee tax liabilities against Mrs. O'Neal's children and grandchildren as donees of the gifts. This opinion summarizes relevant facts from those opinions and sets forth additional findings of fact relevant in determining the value of the deduction on remand.¹

Mrs. O'Neal and her husband, Kirkman O'Neal, ("Mr. O'Neal") made gifts of O'Neal Steel, Inc. ("O'Neal Steel") common stock to their children and grandchildren on November 3, 1987, reported the gifts on timely filed gift tax returns, and paid gift taxes based on the reported values of the gifts. The reported values of the gifts were based upon an amended buy/sell agreement (the "1951 Buy-Sell Agreement") which set option prices for the O'Neal Steel Class A non-voting common stock at $54.00 per share and for the O'Neal Steel Class B voting common stock at $61.00 per share.

Mr. O'Neal died on August 7, 1988. An audit of his estate tax return led to the examination of Mr. and Mrs. O'Neal's 1987 gift tax returns. After the expiration of the statute of limitations for assessing gift tax, generation-skipping transfer tax and penalties against Mr. and Mrs. O'Neal for the 1987 gifts, the IRS asserted that the reported values of the stock were understated and sought to collect additional gift tax, generation-skipping transfer tax, penalties and interest from Mr. and Mrs. O'Neal's children and grandchildren. Mrs. O'Neal died on July 23, 1994, while the IRS proceedings against her children and grandchildren were pending.

Although the 1951 Buy-Sell Agreement could possibly have established the value of the O'Neal Steel common stock for estate tax purposes, the IRS estate tax attorney examining Mr. and Mrs. O'Neal's 1987 gift tax returns determined that buy-sell agreements are not binding for gift tax purposes. See Section 8 of Rev. Rul. 59-60, 1959-1 C.B 237, 1959 WL 12594. The IRS then engaged Mitchell Kaye, an outside fee appraiser, to value the gifted stock.

On February 6, 1992, Mr. Kaye issued a valuation report that opined that the November 3, 1987 value of the O'Neal Steel Class A non-voting common stock was $375.00 per share and that the value of the O'Neal Steel Class B voting common stock was $415.00 per share.² Based upon Mr. Kaye's valuation report, the IRS issued Notices of Transferee Liability (the "Notices of Liability") to Mrs. O'Neal's children and grandchildren on April 13, 1992, with respect to Mrs. O'Neal's 1987 gifts.³ The Notices of Liability asserted $7,038,677.00 in aggregate transferee tax liability for Mrs. O'Neal's gift tax, $197,651.00 in aggregate transferee tax liability for Mrs. O'Neal's generation-skipping transfer tax and $2,170,898.00 in undervaluation penalties pursuant to 26 U.S.C. § 6660.⁴ The Notices of Liability also asserted that the children and grandchildren were liable for interest as provided by law.

At about the same time as the Notices of Liability were issued, Mrs. O'Neal, her children and grandchildren, and Mr. O'Neal's estate employed attorney David D. Aughtry ("Mr. Aughtry") to represent their common interests with regard to the Notices of Liability.⁵

On July 9, 1992, Mr. Aughtry filed petitions in the United States Tax Court on behalf of Mrs. O'Neal's grandchildren contesting the Notices of Liability (the "Tax Court Cases"). The lead counsel for the litigation team representing the IRS in the Tax Court was IRS District Counsel Attorney Michael T. Breen ("Mr. Breen"). The Tax Court Cases were ongoing when Mrs. O'Neal died.

Mrs. O'Neal's children contested their transferee liability by paying the tax shown on their Notices of Liability, filing claims for refund, and then filing suits for refund in the United States District Court for the Northern District of Alabama. Answers were filed by the government in the children's suits for refund in June, 1994, that denied the correctness of the reported values of the gifted stock and asserted that no refund was due to the children. Nothing further happened in the children's refund suits prior to Mrs. O'Neal's death.

The Tax Court Cases were the lead cases challenging the IRS's findings as to the value of the gifted stock and the donees' transferee liability. In these cases, the grandchildren essentially pursued two lines of defense. The first was an argument that the Notices of Liability were untimely due to the IRS's failure to assess gift tax, generation-skipping transfer tax or penalties against the donors. The second defense was that the values of the gifts were correctly reported on the gift tax returns. Mr. Aughtry testified at the trial of this case that he believed that the first defense was the strongest of the two.

The grandchildren obtained a draft valuation study dated March 15, 1992, from the brokerage firm of Sterne, Agee & Leach, Inc. ("Sterne, Agee") that valued both the O'Neal Steel Class A non-voting common stock and O'Neal Steel Class B voting common stock at $182.00 per share as of November 3, 1987. Sterne, Agee revised their draft study on September 14, 1992, to value both the O'Neal Steel Class A nonvoting common stock and the O'Neal Steel Class B voting common stock at $178.00 per share. The Sterne, Agee study was not finalized prior to Mrs. O'Neal's death, and neither draft was furnished to the IRS. Mr. Aughtry testified that when Mrs. O'Neal died, he was not planning to use a Sterne, Agee report in the trial of the Tax Court Cases.

The children and grandchildren also obtained marketability opinions from Jefferson Capital Fund, Ltd., Noble Ventures International, and The Breckenridge Group, Inc., who are venture capitalists or investment bankers, not appraisers of closely-held corporate stock. The marketability opinions indicated that the gifted stock could not be sold for more than the price determined by the 1951 Buy-Sell Agreement. Mr. Aughtry testified that the marketability opinions were not prepared in accordance with the Uniform Standards of Professional Appraisal Practice.

Eventually, the IRS and the grandchildren filed cross-motions for summary judgment addressing the grandchildren's first line of defense—were the Notices of Liability untimely due to the IRS' failure to assess gift tax, generation-skipping transfer tax and penalties against Mr. and Mrs. O'Neal? Arguments on these motions were heard by the Tax Court on September 29, 1993. On April 28, 1994, the Tax Court granted the IRS's motion for partial summary judgment and held that the Notices of Liability were timely and that the grandchildren were liable for the transferee tax liability. O'Neal v. Commissioner, 102 T.C. 666, 1994 WL 151302 (1994). The amount of the grandchildren's transferee tax liability was not addressed by the Tax Court at that time.

Thereafter, the grandchildren filed a Motion to Calendar the Tax Court Cases for trial. In June, 1994, slightly more than a month before Mrs. O'Neal's death, the IRS filed a Notice of Objection to the Motion to Calendar the cases stating that it had just hired Martin D. Hanan ("Mr. Hanan") of Business Valuation Services, Inc., to testify as an expert witness in addition to Mr. Kaye. The grandchildren responded to the hiring of Mr. Hanan by hiring Chris Mercer ("Mr. Mercer") of Mercer Capital to value the gifted stock.⁶ Having just been hired, both Mr. Hanan's work and Mr. Mercer's work had just begun when Mrs. O'Neal died.

At the time of Mrs. O'Neal's death, the value of the assets she owned was $5,303,744.00. Mrs. O'Neal's debts at her death totaled $13,124.00, plus the amount that she owed to her children and...