Koons v. Comm'r Irs
| Decision Date | 27 April 2017 |
| Docket Number | No. 16-10646,No. 16-10648,16-10646,16-10648 |
| Parties | ESTATE OF JOHN F. KOONS, III, Deceased, A. MANUEL ZAPATA, Personal Representative, JOHN F. KOONS III, REVOCABLE TRUST, WILLIAM P. MARTIN, II, A. MANUEL ZAPATA, ROBERT W. MAXWELL, II, KEVEN E. SHELL, MICHAEL S. CAUDILL, Trustee, D. SCOTT ELLIOTT, Trustee, Petitioners-Appellants, v. COMMISSIONER OF IRS, Respondent-Appellee. ESTATE OF JOHN F. KOONS, III, Deceased, A. MANUEL ZAPATA, Personal Representative, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Eleventh Circuit |
[DO NOT PUBLISH]
Petitions for Review of a Decision of the United States Tax Court
Before TJOFLAT and ROSENBAUM, Circuit Judges, and REEVES,* District Judge.
The Internal Revenue Service (IRS) issued a notice of deficiency to the Estate of John F. Koons, III after determining a $42,771,586.75 deficiency in estate tax. It also issued a notice of deficiency to the John F. Koons, III Revocable Trust after determining a deficiency in generation-skipping transfer tax of $15,899,453.13. The Appellants filed notices challenging the deficiencies and the Tax Court consolidated the two cases. The Appellants now appeal the Tax Court's ruling, which concluded that the Commissioner had determined both deficiencies correctly. We affirm the Tax Court's decision for the reasons that follow.
John F. Koons, III died on March 3, 2005, survived by two ex-wives, four children and seven grandchildren. Koons had operated Central Investment Corp. (CIC), which primarily bottled and distributed Pepsi products and also sold vending machine items. Koons owned 46.9% of the company's voting stock and 51.5% of its nonvoting stock in 2004. His children owned most of the remaining stock, either directly or through trusts, while other family members and trusts held the remaining shares.
CIC and PepsiCo, Inc. (PepsiCo), became involved in a dispute over exclusivity rights that led to litigation in 1997. The parties later resolved the dispute. CIC sold its soft-drink and vending-machine businesses to PepsiAmericas, Inc. (PAS), an affiliate of PepsiCo, under the terms of thesettlement. PAS ultimately paid $352,400,000 for CIC's stock and PepsiCo paid an additional $50,000,000 as part of the settlement.
The Koons children were displeased with Koons's plan to place the PAS sale proceeds in CI LLC, where they would be invested in new businesses run by professional advisers. As a result, they conditioned the sale of their CIC shares to PAS on receiving an offer from CI LLC to redeem their interests in CI LLC after the PAS closing. CI LLC offered to redeem each child's interests by letter dated December 21, 2004. The offer included several "terms and conditions," including the method of computing the redemption price. The Koons children consented to the PAS transaction and each accepted the redemption offers before Koons's death. The redemption offers closed on April 30, 2005 (after Koons's death), and final redemption payments were made by July 2005.
The terms of PAS's acquisition of CIC's soft-drink and vending-machine business were outlined in a stock purchase agreement (SPA) executed on December 15, 2004. The SPA provided that PAS would purchase all CIC shares and acquire all of its operations, except for certain assets that were not involved in CIC's soft drink or vending machine businesses. CIC transferred to CI LLC those assets that PAS did not acquire before the PAS sale closed.
CIC distributed its 100% membership interest in CI LLC to CIC's shareholders in proportion to their interests in CIC on January 8, 2005. On January10, 2005, the SPA closed and PAS purchased CIC's shares for $352,400,000. As a result of the sale,1 CI LLC obtained: (1) $352,400,000 in proceeds from the PAS sale; (2) $50,000,000 that PepsiCo paid in the settlement; and (3) the CIC assets that were unrelated to its soda and vending machine businesses and that PAS did not acquire. The unrelated assets that CI LLC retained included four businesses, three of which CI LLC sold shortly after the sale closed. The only remaining operating business was Queen City Racquet Club, valued at $3,815,045.
CI LLC also retained certain obligations following the sale. CI LLC agreed to provide 18 months of transition services in exchange for a monthly fee. It also retained pension plan obligations and was responsible through 2012 for certain warranties relating to environmental, health, and safety liabilities. The SPA also required that CI LLC hold at least $10,000,000 in liquid assets and maintain a positive net worth of at least $40,000,000 at all times.
CI LLC's operating agreement was amended around the time of the sale. The operating agreement provided, among other things, that the LLC would be managed by a Board of Managers, and that the Board of Managers could be removed without cause by a majority vote of the members. Likewise, a majorityvote of the members was needed to take significant actions such as a merger, liquidation, or dissolution. The Board of Managers also was permitted to make distributions at its sole discretion. Further, it was required to consult with a Board of Advisors composed, in part, of Koons's children. Transfers were limited, but members were permitted to transfer membership interests to Koons's lineal descendants such as his children and grandchildren.
CI LLC made a pro rata distribution of $100,000,000 to its members on January 21, 2005. The Koons children received approximately $29,600,000 of this distribution. The amount of each redemption payment was to be reduced in proportion to the amount of the distribution, pursuant to the terms of the redemption offer.
Koons amended the terms of the Revocable Trust on February 4, 2005, to remove his children as beneficiaries and replace them with his grandchildren. Koons contributed his 50.5% interest in CI LLC to the Revocable Trust later that same month. This structure subjected the transfer to a generation-skipping transfer tax.
Koons amended CI LLC's operation agreement to restrict his children's control of the LLC by eliminating the Board of Advisors, of which they were a part. He also removed the children from the list of permitted transferees of membership interests. Next, he directed the trustees to amend CI LLC's operatingagreement to include a limit on discretionary distributions. On February 21, 2005, James B. Koons wrote to his father, complaining that the redemption offer "felt punitive." The letter also raised various complaints and made suggestions regarding the operation of the business. The younger Koons indicated that he expected that the Board of Managers would direct the company to buy operating businesses rather than invest in passive assets. The letter outlined that, if the Board of Managers made decisions that were detrimental to the Koons family, "there w[ould] be litigation." However, he thanked his father for the "exit vehicle" and stated that the Koons children would "like to be gone."
Koons died on March 3, 2005, against this backdrop. The Revocable Trust held a 50.50% interest in CI LLC on the date of his death, which included a 46.94% voting interest and a 51.59% nonvoting interest. CI LLC had net assets totaling $317,909,786 on the date of Koons's death.
The redemption offers the children had signed prior to Koons's death closed on April 30, 2005. Once they closed, the Revocable Trust held a 70.93% interest in CI LLC, which included a 70.42% voting interest and a 71.07% nonvoting interest.
The Revocable Trust comprised the majority of the Estate's assets with the Trust's interest in CI LLC being its primary asset. The Estate's remaining liquid assets, however, were insufficient to pay its tax liability. The trustees of the Estatedeclined to direct a distribution of the Revocable Trust's interest in CI LLC to pay the tax liability, believing that immediate payment would hinder CI LLC's plan to invest in operating businesses. As a result, the trustees obtained a loan from CI LLC for $10,750,000 in exchange for a promissory note bearing an annual interest rate of 9.5%. No payment was due for 18 years and principal and interest were scheduled to be repaid in 14 installments between August 2024 and February 2031. Prepayments were not permitted and the projected interest payments would total $71,419,497. Because the Revocable Trust's primary asset was its interest in CI LLC, it anticipated that the loan would be repaid with distributions from CI LLC.
CI LLC had over $200,000,000 in liquid assets at the time of the loan. Additionally, it owned two operating companies: Queen City Racquet Club, LLC, and a company CI LLC had acquired in 2005, T & T Pallets, Inc. These companies, however, accounted for only 4% of CI LLC's assets. During the time leading up to the litigation before the Tax Court, CI LLC had acquired only one other company, CK Products LLC, for approximately $7,300,000. Thus, CI LLC continued to be comprised largely of liquid assets.
The Estate filed its tax return in June 2006, claiming a $71,419,497 deduction for interest on the loan as an administrative expense. It also reported the market value of the Revocable Trust's interest in CI LLC to have been$117,197,442.72 as of the date of Koons's death. This amount was based on a valuation report prepared by Dr. Mukesh Bajaj on May 31, 2006.
The Commissioner determined a $42,771,586.75 estate tax deficiency and a $15,899,463 generation-skipping transfer tax deficiency due to her determination that the interest payment was not entitled to a deduction and that the return understated the value of the Trust's interest in CI LLC. The Commissioner originally concluded that the value of the Trust's interest was $136,462,776, rather than $117,197,442.72, as reported. However, she later amended her answer to assert an increased deficiency after concluding that the value of the CI LLC interest at...
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