Knight v. Comm'r of Internal Revenue

• Decision Date: 30 November 2000
• Docket Number: No. 11955–98,12032–98.1,11955–98
• Citation: Knight v. Comm'r of Internal Revenue, 115 T.C. 506, 115 T.C. No. 36 (T.C. 2000)
• Parties: Ina F. KNIGHT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHerbert D. KNIGHT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

115 T.C. 506

115 T.C. No. 36

Ina F. KNIGHT, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, RespondentHerbert D. KNIGHT, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 11955–98

12032–98.1

United States Tax Court.

Nov. 30, 2000.

Taxpayers petitioned for redetermination of deficiencies in gift tax arising from transfer of family limited partnership (FLP) interests to their children's trusts.The Tax Court, Colvin, J., held that: (1) FLP was recognized for gift tax purposes; (2) gifts were valued at pro rata net asset value (NAV) of FLP interests with discounts applied; and (3) provision on certain lapsing rights and restriction did not apply.

Decision for taxpayer.

Laro and Marvel, JJ., concurred in result only.

Foley, J., concurred in result in written opinion, in which Wells, Chief Judge joined.

Beghe, J., dissented in written opinion.On Dec. 28, 1994, Ps established a trust of which P–H was trustee(the management trust), a family limited partnership (the partnership) of which the management trust was the general partner, and trusts for the benefit of each of Ps' two adult children (the children's trusts).Ps transferred three parcels of real property used by Ps and their children and some financial assets to the partnership.Each P transferred a 22.3–percent interest in the partnership to each of their children's trusts.The parties stipulated that the steps to create the partnership satisfied all requirements under Texas law, and that the partnership has been a limited partnership under Texas law since it was created.Held: We recognize the partnership for Federal gift tax purposes.Held, further, the value of each of Ps' gifts to their children's trusts in 1994 was $394,515; i.e., 22.3 percent of the value of the real property and financial assets Ps transferred to the partnership, reduced by minority and lack of marketability discounts totaling 15 percent.Held, further, sec. 2704(b), I.R.C., does not apply to this transaction.SeeKerr v. Commissioner, 113 T.C. 449, 1999 WL 1247551(1999).William R. Cousins III, Robyn A. Frohlin, Todd Allen Kraft, Robert M. Bolton, Robert Don Collier, and John E. Banks, Jr., for petitioners.

Deborah H. Delgado, Gerald Brantley, and James G. MacDonald, for respondent.

COLVIN, J.

In separate notices of deficiency sent to each petitioner, respondent determined that each petitioner has a gift tax deficiency of $120,866 for 1994.

Petitioners formed a family limited partnership called the Herbert D. Knight Limited Partnership(the partnership), and gave interests in it to trusts they established for their children.After concessions, the issues for decision are:

1.Whether, as respondent contends, the partnership is disregarded for Federal gift tax purposes.We hold that it is not.

2.Whether, as petitioners contend, the fair market value of petitioners' gifts is the value of the assets in the partnership reduced by portfolio, minority interest, and lack of marketability discounts totaling 44 percent.We hold that discounts totaling 15 percent apply.

3.Whether the fair market value of each of petitioners' gifts to each children's trust on December 28, 1994, is $263,165 as petitioners contend, $450,086 as respondent contends, or some other amount.We hold that it is $394,515.

4.Whether section 2704(b) applies.We hold that it does not.

Unless otherwise indicated, section references are to the Internal Revenue Code.Rule references are to the Tax Court Rules of Practice and Procedure.References to petitioner are to Herbert D. Knight.References to Mrs. Knight are to petitionerIna F. Knight.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

A. Petitioners1.Petitioners' Family

Petitioners were married and lived in San Antonio, Texas, when they filed their petitions and at the time of trial.They have two adult children, Mary Faye Knight(Mary Knight) and Douglas Dale Knight(Douglas Knight).Petitioners' children were not married, and petitioners had no grandchildren at the time of trial.Petitioner worked for Luby's Cafeterias for 49 years and retired at age 65 on December 31, 1992, as a senior vice president.In 1992, Douglas Knight was 40, and Mary Knight was 33.By December 1994, petitioners owned assets worth about $10 million, most of which was Luby's Cafeterias stock.Petitioners were both in excellent health at the time of trial.2.Petitioners' Real Property

In 1861, petitioner's great-grandfather bought a 290–acre ranch (the ranch) in Freestone County, Texas, about 120 acres of which is pasture.Knight family members are buried in a cemetery on the ranch.Petitioner was raised on the ranch.By 1959, parts of the ranch were owned by several members of petitioner's family.In 1959, petitioner began to buy parts of the ranch for sentimental reasons.Petitioner generally has 55 to 75 cattle on the ranch.The ranch has never been profitable while petitioner owned it.

Petitioners bought their family residence at 6219 Dilbeck in Dallas, Texas, on June 1, 1973.Petitioners moved to San Antonio in 1981.Douglas Knight lived at 6219 Dilbeck rent-free from 1984 to the date of trial.Petitioners bought a residence at 14827 Chancey in Addison, Texas, on May 12, 1993.Mary Knight has lived there rent-free from 1993 to the date of trial except from November 1995 to September 1997.

Petitioner managed the ranch and the houses before December 28, 1994.Petitioner paid the real estate taxes and insurance on those properties before December 28, 1994.

B.The Partnership1.Initial Discussions

Robert Gilliam(Gilliam), a certified public accountant, met petitioner in the 1970's while Gilliam was auditing Luby's Cafeterias.Petitioners became Gilliam's tax clients in 1992 or 1993.Gilliam and petitioner discussed estate planning in 1993 and 1994.

Gilliam knew that petitioners had about $10 million in assets.Gilliam and petitioner discussed the fact that, if petitioners did no estate planning, Federal transfer taxes would equal 50 to 55 percent of their estate.Gilliam and petitioner discussed the tax benefits of estate planning.Gilliam told petitioners that they could claim discounts for transferred limited partnership interests if supported by a professional appraisal.Gilliam believed that petitioners could form a trust to help protect their assets from creditors and that a limited partnership would add another layer of protection for those assets.

Petitioner sought estate planning advice from John Banks, Jr.(Banks), in 1993 or 1994.Banks had been petitioners' attorney since 1981.Petitioners met with Gilliam or Banks several times in November and December 1994.Late in 1994, Gilliam and Banks devised and helped to implement an estate plan for petitioners using a family limited partnership and related trusts.

2.Implementing the Plan

On December 6, 1994, petitioner opened an investment account at Broadway National Bank in the name of petitioners' family limited partnership, the Herbert D. Knight limited partnership(created on December 28, 1994, as described below), and transferred Treasury notes to it.On December 12, 1994, petitioners opened a checking account for their partnership at Broadway National Bank and transferred $10,000 to it from their personal account.On December 15, 1994, petitioners transferred $558,939.43 worth of a USAA municipal bond fund from their personal investment account to the partnership.

On December 28, 1994, the following occurred:

a. Petitioners signed documents which created the partnership, consisting of 100 units of ownership.The steps followed in the creation of the partnership satisfied all requirements under Texas law to create a limited partnership.

b. Petitioners conveyed the ranch and the real property at 6219 Dilbeck and 14827 Chancey to the partnership.

c. Petitioners created the Knight Management Trust (management trust).The steps followed in the creation of the management trust satisfied all requirements under Texas law to create a trust.The management trust was the partnership's general partner.

d. Petitioners each transferred a one-half unit of the partnership to the management trust.That unit is the only asset held by the management trust.Petitioners each owned a 49.5–percent interest in the partnership as limited partners.

e. Petitioners created trusts for Mary Knight and Douglas Knight(the children's trusts).The documents petitioners executed were sufficient under Texas law to create the children's trusts.Douglas Knight and Mary Knight were each the beneficiary and trustee of the children's trust bearing their name.

f. Petitioners each signed codicils to their wills in which they changed the bequests to their children to bequests to the children's trusts.

g. Petitioners each transferred a 22.3–percent interest in the partnership to each of the children's trusts.After those transfers, petitioners each retained a 4.9–percent interest in the partnership as limited partners.

3.The Partnership Agreement

The partnership has been a limited partnership under Texas law since it was created.Article 9 of the partnership agreement prohibits any partner from withdrawing from the partnership or demanding the return of any of his or her capital contribution or the balance in that partner's capital account.Article 14 provides that the partnership will continue for 50 years, unless all partners consent to a dissolution.Under the partnership agreement, petitioner, as trustee of the management trust, could sell any asset or part of any asset at any time.

The fair market values (before any discounts) of partnership assets on December 28, 1994, were as follows:

+------------------------------------------------------+
                ¦Freestone County Ranch (with mineral rights)¦$182,251 ¦
                +--------------------------------------------+---------¦
                ¦Residential property (6219 Dilbeck)         ¦166,880  ¦
                +--------------------------------------------+---------¦
                ¦Residential property (14827 Chancey)

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