Jameson v. Comm'r of Internal Revenue

• Decision Date: 18 September 2001
• Docket Number: No. 00-60489,00-60489
• Parties: (5th Cir. 2001) ESTATE OF HELEN BOLTON JAMESON, DECEASED, NORTHERN TRUST BANK OF TEXAS, N.A., INDEPENDENT EXECUTOR, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
• Court: U.S. Court of Appeals — Fifth Circuit

Page 366

267 F.3d 366 (5th Cir. 2001)

ESTATE OF HELEN BOLTON JAMESON, DECEASED, NORTHERN TRUST BANK OF TEXAS, N.A., INDEPENDENT EXECUTOR, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 00-60489

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

September 18, 2001

On Appeal from the United States Tax Court

Before JONES, DeMOSS, and BENAVIDES, Circuit Judges.

EDITH H. JONES, Circuit Judge:

The Estate of Helen Jameson appeals following a Tax Court decision assessing a deficiency against it. The Estate argues that the Tax Court clearly erred in valuing assets of Johnco, Inc. ("Johnco"), a holding company that is part of the estate. It also raises a plausible but unsustainable constitutional challenge to the estate tax as applied in this case. As we agree that the court's valuations were in error, we vacate and remand for further proceedings.

I. FACTS

This dispute arises from a series of bequests from John Jameson to his wife Helen Jameson, and from Helen to their children Andrew and Dinah Jameson.

A.Mr. Jameson's Bequest of Johnco Shares to Andrew and Helen.

Mr. Jameson incorporated the privately held holding company Johnco in 1968. At his death in May 1990, he owned 82,865 of Johnco's 83,000 shares as separate property. In his will, Mr. Jameson bequeathed $106,251 in Johnco shares to Andrew to fund a unified estate tax credit, directing that the shares be "valued by independent appraisal as of my date of death." The remainder of Mr. Jameson's shares passed to his wife.

Helen, the initial executrix of Mr. Jameson's estate, filed an estate tax return in which she reported the value of the Johnco stock passing through the estate at $86.80 per share. The source of this share value is unclear. This tax return was never amended.

Helen died in September 1991. Northern Trust Bank of Texas ("Northern Trust") became the executor of both spouses' estates. Northern Trust asked Rauscher Pierce Refsnes, Inc. ("Rauscher") to appraise both estates in December 1992. Although the appraisal of Mr. Jameson's estate is not in the record, its conclusion that Johnco shares were worth only $44.65 per share at the time of his death appears in his wife's estate appraisal.

Northern Trust used the $44.65 figure to calculate that Andrew was entitled to 2,380 Johnco shares to satisfy the $106,251 he was entitled to receive under Mr. Jameson's will. Northern Trust concluded that Helen received John's remaining 80,485 shares of Johnco. Had Northern Trust used the $86.80 share value, Andrew would have received 1,224 shares and Mrs. Jameson would have received 81,641 shares.

B.The Family Settlement Agreement.

Mrs. Jameson left Andrew and Dinah equal shares of her estate. The siblings entered into a December 1993 settlement agreement ("Family Settlement Agreement") dividing her estate. Separate counsel represented Andrew and Dinah during the negotiations.

The Family Settlement Agreement assigned a value of $4.025 million to Mrs. Jameson's estate's 80,485 shares of Johnco and gave the shares to Andrew. This established an implicit per share value of $ 50.01. Dinah received $ 4.025 million in cash, marketable securities, and other assets.

C.Johnco's Timber Property.

Johnco's principal asset is 5,405 acres of timberland in Louisiana (the "Timber Property") that it acquired in 1986. The company does not harvest or transport its own timber. Rather, Johnco earns over 80% of its revenue by receiving fees from companies that harvest timber on the property. The Timber Property's gross revenues averaged roughly $154,000 annually from 1988-91.¹ Johnco's average net income over this period was $60,803. The parties stipulated that the Timber Property was "well-managed."

Northern Trust commissioned an appraisal of the Timber Property by consultant forester George Screpetis in 1992. Screpetis noted that the Timber Property was outstanding for timber production and opined that a buyer of the property would most likely be a company in the forest products business.

Forester Robert Baker prepared a 1996 report on the Timber Property on behalf of the IRS. The report stated that the Timber Property was extremely productive and that its best use was for timber production. Commending Johnco's management of the property, the report predicted that private investors, pension funds, or local timber companies would be most likely to purchase it.

Harold Elliott, a consulting forester who had worked for the Jamesons for many years, testified at trial that Johnco's management was interested primarily in covering expenses and not in making a big profit. Elliott testified that Johnco cut timber conservatively. He also testified that timber grew on the property at the rate of 8 to 10% a year.

The parties stipulated that, at Mrs. Jameson's death, Johnco had a basis of $217,850 in the Timber Property and that the property was worth $6 million. At trial, the parties disputed how the value of Johnco's interest in the Timber Property was affected by the capital gains taxes the company would incur through timber or land sales.

Both parties presented expert reports and testimony on Johnco's fair market value given its low basis in the Timber Property. Clyde Buck, a managing director of Rauscher, prepared a new appraisal on behalf of the estate ("New Rauscher Appraisal"). This appraisal considered three possible scenarios for a buyer of Johnco under discount rates ranging from 20 to 30%: 1) an immediate "fire sale" of the Timber Property; 2) a rapid but controlled sale of Timber Property parcels within twenty-four months; and 3) ongoing operation of the Timber Property.

Buck testified that he had no information that Johnco was operating in a wasteful manner. Based on the stipulation that the Timber Property was worth $ 6 million, however, Buck concluded that a buyer of Johnco would realize the most income through an immediate liquidation. On the other hand, a buyer would realize the least income by far if it operated the Timber Property as a going concern. After subtracting the taxes that a buyer would incur by immediately selling the Timber Property, Buck concluded that Johnco's interest in the property was worth only $4.8 million.

John Lax of Arthur Andersen LLP also presented an appraisal on behalf of Mrs. Jameson's Estate ("Andersen Appraisal"). Lax estimated the debt payments a potential buyer would incur if it financed $5 million of Johnco's purchase price. He concluded that Johnco's projected future cash flow would not cover the debt payments. He also asserted that a buyer would demand a return on equity of 17-22% for a risky investment like the Timber Property. Lax concluded that a buyer of Johnco would liquidate the Timber Property within a year. After calculating capital gains taxes based on this conclusion, Lax determined that Johnco's interest in the Timber Property was worth only $4.13 million.

Francis Burns then testified and presented a report on behalf of the IRS. Burns was a principal in the financial consulting firm IPC Group LLC. Burns argued against any capital gains discount based on an immediate liquidation of the Timber Property by a buyer of Johnco. He stated that this discount was counterintuitive, since it assumed that an entity would purchase Johnco and then "immediately turn around and sell what [it] just purchased."

D.Johnco's Tanglewood Property.

Johnco also owned a parcel of unimproved land in Harris County, Texas (the "Tanglewood Property"). The parties stipulated that this property was worth $240,000 at Helen's death, and that Johnco held a basis of $110,740 in it.

Mrs. Jameson's Estate did not specifically indicate that a buyer of Johnco would immediately liquidate the Tanglewood Property, but the New Rauscher Appraisal incorporated the value of this property when it calculated a capital gains discount for Johnco's assets. Thus, this appraisal assumed that a buyer of Johnco would realize capital gains through an immediate sale of the Tanglewood Property.

E.The Tax Court decision.

The Tax Court first considered the number of Johnco shares that passed to Mrs. Jameson's Estate after John's bequest of $106,251 in Johnco shares to Andrew. The court observed that the $44.65 appraised share value used by Helen's estate managers conflicted with the $86.80 share value reported on Mr. Jameson's estate tax return. The court also noted that the $44.65 share value reduced Mr. Jameson's property available for a marital deduction, and it opined that Mr. Jameson's will intended to maximize this deduction. While noting that the 1992 appraisal of Mr. Jameson's estate was not in the record, the court expressed doubt about Rauscher's valuation methodologies. The court applied the $86.80 share value and concluded that Mrs Jameson's Estate owned 81,641 Johnco shares.

The Tax Court then turned to valuing Johnco. Although the court acknowledged that Andrew and Dinah negotiated the 1993 Family Settlement Agreement at arm's length, it refused to adopt the share value adopted in that agreement since the agreement relied on the Rauscher appraisal, and the appraisal was flawed because it assumed a liquidation of the Timber Property.

The court then considered capital gains tax discounts for Johnco's assets based on the company's low basis in them. It refused to apply a discount for the Tanglewood Property, stating that the parties had failed to address this issue. The court did decide to apply a discount for the capital gains tax liability that Johnco would incur from ongoing sales of timber. It rejected a discount reflecting an immediate sale of the Timber Property, however, concluding that a buyer would operate the property on an ongoing basis.

The court designed a model to estimate the capital gains taxes that Johnco would incur if it operated the Timber Property as a going concern. The parties had not presented evidence on this specific issue. The court's model assumed that Johnco would sell 10% of...