Kerr v. Comm'r of Internal Revenue

• Decision Date: 23 December 1999
• Docket Number: No. 14449–98.,14449–98.
• Citation: Kerr v. Comm'r of Internal Revenue, 113 T.C. 449, 113 T.C. No. 30, 2000 USTC P 47816 (T.C. 1999)
• Parties: Baine P. and Mildred C. KERR, Donors, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

113 T.C. 449

113 T.C. No. 30

2000-1 USTC P 47,816

Baine P. and Mildred C. KERR, Donors, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 14449–98.

United States Tax Court.

Dec. 23, 1999.

John W. Porter, for petitioners.

Lillian D. Brigman and John D. Maceachen, for respondent.

OPINION

JACOBS, J.

In 1993, Ps and their children formed two family limited partnerships (KFLP and KILP). The KFLP and KILP partnership agreements contain identical restrictions on liquidation of the partnerships. In June 1994, Ps transferred limited partnership interests in KFLP and KILP to the University of Texas (the university).

On Dec. 28, 1994, Ps created separate grantor retained annuity trusts (GRAT's). Ps each transferred a 44.535–percent class B limited partnership interest in KFLP to their GRAT's. The GRAT's remainder interests were intended to benefit Ps grandchildren through generation-skipping trusts.

On Dec. 30, 1994, the university was admitted as a limited partner of KILP. On Dec. 31, 1994 and 1995, Ps transferred limited partnership interests in KILP to their children.

Ps filed Federal gift tax returns for 1994 and 1995. Ps computed the value of the limited partnership interests in KFLP that they transferred to the GRAT's by applying discounts for lack of liquidity and minority interest. Ps computed the value of the limited partnership interests in KILP that they transferred to their children by applying a discount for lack of liquidity. R determined that sec. 2704(b), I.R.C., bars Ps from applying a discount for lack of liquidity in computing the value of the partnership interests that Ps transferred to the GRAT's and to their children.

Ps filed a motion for partial summary judgment arguing that sec. 2704(b), I.R.C. is not applicable alternatively because: (1) The GRAT's trustees received only assignee interests, as opposed to limited partnership interests; (2) the disputed transfers must be valued as assignee interests under sec. 25.2512–1, Gift Tax Regs.; and (3) the restrictions on liquidation set forth in the partnership agreements do not constitute “applicable restrictions” within the meaning of sec. 2704(b), I.R.C.

Held: Ps transferred limited partnership interests to the GRAT's in both form and substance.

Held further: Pursuant to sec. 25.2512–1, Gift Tax Regs., the value of the limited partnership interests is equal to the price that a hypothetical willing buyer would pay to a willing seller for the limited partnership interests.

Held further: The restrictions on liquidation in dispute do not constitute “applicable restrictions” within the meaning of sec. 2704(b), I.R.C.

This matter is before the Court on petitioners' motion for partial summary judgment, filed pursuant to Rule 121.¹ Petitioners contend that they are entitled to partial summary judgment that section 2704(b) is not applicable in valuing the limited partnership interests that they transferred to their grantor retained annuity trusts and to their children during 1994 and 1995.² For the reasons set forth below, we will grant petitioners' motion.

Background³

Baine P. Kerr and Mildred C. Kerr were married in 1942 and have four adult children, Baine P. Kerr, Jr., John Caldwell Kerr, James Robinson Kerr, and Mary Kerr Winters (the Kerr children). The Kerr children are financially independent. Petitioners have 13 grandchildren.

Petitioners both graduated from the University of Texas. Baine P. Kerr (petitioner) also graduated from the University of Texas Law School.

After serving in World War II, petitioner joined the law firm of Baker & Botts in Houston, Texas, subsequently was admitted as a partner, and ultimately managed the firm's corporate law department.

Petitioner left Baker & Botts to serve in various executive positions at Pennzoil Co. Between 1964 and 1994, petitioner served on Pennzoil's board of directors and as president. In 1989, he received a $10 million bonus for work that he had performed in a lawsuit that Pennzoil had filed against Texaco.

S. Stacey Eastland (Eastland), an attorney at Baker & Botts, advised petitioners on estate planning matters for many years. Eastland has written extensively on the use of family limited partnerships (and particularly transfers of assignee interests) as an estate planning tool.⁴ In September 1993, Eastland proposed that petitioners create two limited partnerships. Eastland advised petitioners that the limited partnerships could be used as a source for making gifts to their children. Eastland further advised petitioners that the partnerships should include a charity as a partner in light of the recent enactment of section 2704 and to “make sure that traditional valuation rules apply to the partnerships.” ⁵

Kerr Issue GST Trust

On December 29, 1993, petitioners, as grantors, and their children, as trustees, executed a document entitled “Agreement Creating the Kerr Issue GST Trusts”. The agreement provided that each of the Kerr children would act as the trustee of a separate trust under which he or she would be the primary beneficiary. The agreement further provided that each trust would terminate upon the death of the primary beneficiary and that any remaining trust property would pass to the living issue of the primary beneficiary; i.e., the Kerr grandchildren. On December 29, 1993, petitioners executed separate wills, which included “pour over” provisions to the Kerr Issue GST Trusts in an amount equal to the available generation-skipping tax exemption.

Kerr Family Limited Partnership

On December 31, 1993, petitioners and the Kerr children executed an agreement forming the Kerr Family Limited Partnership (KFLP) under the Texas Revised Limited Partnership Act (TRLPA), Tex.Rev.Civ. Stat. Ann. art. 6132a–1 (West Supp.1993). Petitioners made all capital contributions to KFLP in the form of three life insurance policies on their lives with a face amount totaling approximately $7 million. The Kerr children did not make any capital contributions to KFLP.

At the time KFLP was formed, petitioners were the sole general partners. However, petitioners immediately assigned a portion of their general partnership interest to each of the Kerr children. In particular, each of the Kerr children received a .2325–percent KFLP general partnership interest. There is no evidence in the record that petitioners executed a written consent admitting the Kerr children as general partners of KFLP.

Following the transfers described above, petitioners retained the following partnership interests in KFLP: (1) A combined 100–percent class A limited partnership interest; ⁶ (2) a combined 2–percent general partnership interest; and (3) a combined 97.07–percent class B limited partnership interest.

Kerr Interests Limited Partnership

On December 31, 1993, petitioners, their children, and KFLP executed an agreement forming the Kerr Interests Limited Partnership (KILP) under TRLPA. Petitioners made all capital contributions to KILP in the form of stocks, bonds, and real estate with an aggregate fair market value of approximately $11 million. The Kerr children did not make any capital contributions to KILP.

At the time KILP was formed, petitioners were the sole general partners. However, petitioners immediately assigned all of their general partnership interest in KILP to KFLP and a portion of their class B limited partnership interest in KILP to KFLP and the Kerr children. In particular, KFLP received a 2–percent general partnership interest and an 18–percent class B limited partnership interest in KILP, while the Kerr children each received a .0785–percent class B limited partnership interest in KILP. There is no evidence in the record that petitioners executed a written consent admitting KFLP as a general partner of KILP.

Following the transfers described above, petitioners retained a combined 100–percent class A limited partnership interest in KILP ⁷ and a combined 76.686–percent class B limited partnership interest.

In 1995, petitioners transferred additional assets to KILP with an aggregate fair market value of approximately $9.9 million.

Partnership Agreements

The KFLP and KILP partnership agreements are identical in all material respects. They include a number of provisions pertinent to the pending motion.

Section 3.03 of the partnership agreements states that the general partners shall appoint petitioners to serve jointly as the managing partner, that if either petitioner fails or ceases to serve as managing partner, then the other shall continue to serve as managing partner, and, if both petitioners cease or fail to serve as managing partner, then Mary Kerr Winters shall serve as managing partner. Section 3.10(b) states the general rule that no limited partner shall have any control over the management of the partnerships. However, section 3.09(e) states that the partnership shall not take action with respect to certain enumerated “Major Decisions” without prior written consent of a majority of the limited partners. Section 3.10(e) identifies “Major Decisions” as extraordinary events such as the partnership's filing a petition in bankruptcy, any act that would make it impossible to carry on the partnership's business, and any act in contravention of the partnership agreement.

Section 3.06 states that no person shall be admitted as a general or limited partner without the consent of all general partners, except as provided in article VIII of the agreements.⁸ Section 3 .10(a) states that no other person may become a limited partner of the partnerships except by way of a transfer permitted under and effected in compliance with the partnership agreements.

Section 3.10(c) states that limited partners shall not be entitled to the withdrawal or return of their contributions to the partnerships except to the extent, if any, that distributions are made pursuant to the partnership agreements or upon termination of the partnerships.

Section 8.01 states the general rule that no limited partner or spouse of a...