Estate of Smith v. United States

Decision Date13 February 2012
Docket NumberNo. 07-676T,07-676T
PartiesESTATE OF RANKIN M. SMITH, SR., SUNTRUST BANK, TAYLOR W. SMITH, and RANKIN M. SMITH, JR., CO-EXECUTORS, Plaintiffs, v. UNITED STATES, Defendant.
CourtU.S. Claims Court

Estate Tax; 26 U.S.C. § 2704, "Treatment of Certain Lapsing Rights and Restrictions"

Judith A. Mather, Dow Lohnes PLLC, Washington, D.C., for the plaintiffs. With her were Richard L. Braunstein, Alex L. Bertoldo, and Bernard J. Long, Dow Lohnes PLLC, Washington, D.C., of counsel.

Benjamin C. King, Jr., Court of Federal Claims Section, Tax Division, United States Department of Justice, Washington, D.C., for the defendant. With him were G. Robson Stewart, Assistant Chief, Court of Federal Claims Section, David I. Pincus, Chief, Court of Federal Claims Section, and John A. DiCicco, Principal Deputy Assistant Attorney General, Tax Division.

OPINION

HORN, J.

FINDINGS OF FACT

Plaintiffs, the Estate of Rankin M. Smith, Sr., Suntrust Bank, Taylor W. Smith, and Rankin M. Smith, Jr., Co-Executors (hereafter, the Estate), filed suit against the United States pursuant to 28 U.S.C. § 1346(a)(1) (2006), seeking a refund of estate taxes and interest on the value of property included in the taxable Estate of Rankin Smith, Sr. (Mr. Smith).

Plaintiffs allege that the Internal Revenue Service (IRS) incorrectly valued shares of stock held by decedent at the time of his death and of real property owned by Falcon's Nest I, Ltd., in which decedent held an interest, as well as erroneously disallowed deductions for administration expenses paid or incurred by the Estate,including interest payments. The parties have stipulated to two different fair market values for the relevant shares of stock depending on whether 26 U.S.C. § 2704 (2006) applies, and have agreed to the fair market value of the real property at issue owned by Falcons Nest I., Ltd. Upon resolution of the application of Section 2704, the value of decedent's stock includable in the decedent's Estate can be set. This resolution, combined with the parties' settlement of the value of the Falcons Nest I, Ltd. property, can set the value of the gross Estate and, together with the resolution of the remaining issues in the case, will lead to a final judgment. The parties have already indicated that the issues related to allowance of administration expenses have been partially resolved and that they are working to finalize agreement as to the remaining expenses and computations.

In the cross-motions for partial summary judgment, the parties have stipulated that the legal issue to be decided by the court in this opinion is:

Under the Internal Revenue Code's general estate tax principles, the Estate's Shares are to be valued as Class B Shares for purposes of determining the estate tax. At issue is whether [Internal Revenue] Code section 2704 applies to the automatic conversion of the Company's Class A Shares into Class B Shares upon Mr. Smith's death, including whether the creation of and restrictions on the disproportionate voting rights of the Class A Shares occurred prior to the October 8, 1990 effective date of section 2704.

Under the provisions of the Articles of Incorporation of Mr. Smith's company, The Five Smiths, Inc. (hereafter, the Company), Mr. Smith's Class A shares automatically converted into Class B shares upon his death on October 26, 1997. Class A shares enjoyed the enhanced voting right of 11.64 votes per share, while Class B shares possessed 1 vote per share. The parties have agreed that, if 26 U.S.C. § 2704 applies, as defendant argues, then for purposes of the estate tax, the fair market value of the Class A shares was $30,000,000.00; if, as plaintiffs argue, 26 U.S.C. § 2704 does not apply, then for purposes of the estate tax, the fair market value of the Class B shares was $22,500,000.00. Thus, the applicability or inapplicability of 26 U.S.C. § 2704 determines whether the higher amount will be included in the Estate for estate tax purposes.

In 1965, Mr. Smith formed the Company for the purpose of operating a National Football League (NFL) franchise. Mr. Smith received a franchise from the NFL on June 30, 1965, which he operated until his death on October 26, 1997. The Company owned and managed the team until it was sold in February 2002.

The Company was taxable as a Subchapter C corporation from its formation in 1965, until December 31, 1986. Prior to December 31, 1986, the parties have stipulated that the Company had issued 23,750 shares of common stock, which represented 14% of the total votes, and another 152,000 shares of voting preferred stock, which represented the remaining 86% of the total votes. The Companydetermined that it preferred to be taxed as a Subchapter S corporation, and on December 31, 1986, the Company was converted from a Subchapter C corporation to a Subchapter S corporation. The Company's Articles of Incorporation were amended in the Articles of Amendment to the Restated Articles of Incorporation of The Five Smiths, Inc., dated December 31, 1986. In order to convert to a Subchapter S corporation, the Company had to eliminate its preferred stock. Therefore, as a consequence of the 1986 conversion to a Subchapter S corporation, the two prior classes of shares, preferred and common, were converted into two classes of common stock, Class A common stock and Class B common stock, with each class subject to its own Shareholders Agreement. While both classes of stock had voting rights, Class A stock had 11.64 votes per share, and Class B stock had 1 vote per share. This voting rights ratio preserved the relative voting rights between preferred and common shareholders which had existed prior to the December 31, 1986, conversion to the Subchapter S corporation. Preferred shareholders converted their preferred shares into Class A common shares, and retained their enhanced voting power in the Company. Mr. Smith held only Class A stock. The remainder of the Class A stock and all of the Class B stock was held by Mr. Smith's family, or in trusts for the family's benefit. Reflecting Mr. Smith's control of the Company, immediately prior to his death, he held Class A common stock representing 81.75% of the total vote of the combined Class A and Class B common stock of the Company. The associated Shareholders Agreements placed restrictions on the transfer or sale of the Company's stock.

At the time of the 1986 conversion from a Subchapter C corporation to a Subchapter S corporation, of the 13,050 enhanced voting right, Class A shares outstanding, Mr. Smith held 12,424 of the Class A shares and Mr. Smith's family held the remaining 626 Class A shares, as well as all of the 25,000 outstanding shares of Class B stock. At this stage, Mr. Smith's Class A shares (with 11.64 votes per share) gave him 81.75% of the votes of all of the stock outstanding. His family's Class A shares and Class B shares (with 1 vote per share) gave them the remaining 18.25% of the total voting power. As of December 31, 1986, Mr. Smith and his family held 100% of the votes.

Accompanying the 1986 amendment to the Articles of Incorporation of the Company were separate Shareholders Agreements for Class A and Class B stock. The parties stipulated that the December 31, 1986, Class A Shareholders Agreement permitted the Class A shareholders to sell their Class A stock to the Company at the fixed price of $1,176.40 per share, and permitted no other sales of the Class A stock.1 The Class A Shareholders Agreement also permitted the Company, at the death of a Class A shareholder, such as Mr. Smith, to purchase that shareholder's Class A shares at a price set by the agreement. The sale of Class A shares, or redemption by theCompany upon the death of a Class A shareholder, would eliminate the Class A shares and their enhanced voting right. The Class A Shareholders Agreement also permitted Mr. Smith, and other Class A shareholders, to bequeath their Class A shares, with their enhanced voting rights, to their family and/or to other Company shareholders by gift, will, trust, or intestate succession.

In 1990, some of Mr. Smith's children sought to sell a portion of their Class B common stock. Ultimately, third party purchaser John Imlay acquired 2,283 shares of Class B stock, pursuant to a February 21, 1991, Stock Purchase Agreement. Third party purchaser Tom Watson Brown also acquired 2,283 shares of Class B stock, pursuant to a March 25, 1991, Stock Purchase Agreement. On March 25, 1991, the Company's Board of Directors and shareholders executed Unanimous Consents approving the February 21 and March 25, 1991, Stock Purchase Agreements for what the parties have called the Imlay-Brown Transaction. Mr. Imlay and Mr. Brown each acquired a 6% interest in the Company through this transaction.2 To reflect the Imlay-Brown Transaction, a new, single Shareholders Agreement was executed on March 25, 1991, which replaced the December 31, 1986, Class A Common Stock Shareholders Agreement and Class B Common Stock Shareholders Agreement. On March 27, 1991, the earlier December 31, 1986, Articles of Amendment to the Restated Articles of Incorporation of The Five Smiths, Inc., was amended by the addition of an Article VII.3 The purchase of the shares in the Imlay-Brown Transaction had been conditioned on the Company amending its Articles of Incorporation to provide for the automatic conversion of the Company's Class A shares into Class B shares, on a one-for-basis, upon either (1) the sale or transfer for consideration of any Class A shares during Mr. Smith's lifetime or (2) Mr. Smith's death.

The March 27, 1991, Articles of Amendment, Article VII, implemented the conditions of the Imlay-Brown Transaction, stating:

Shares of Class A Common Stock shall automatically be converted into shares of Class B Common Stock on a one-for-one basis upon the sale or transfer for consideration of any such shares of Class A Common Stock by the original holder thereof. All outstanding shares of Class A Common Stock
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