O'Reilly v. C.I.R.

• Decision Date: 01 September 1992
• Docket Number: 91-2009,Nos. 91-2004,s. 91-2004
• Citation: 973 F.2d 1403
• Parties: -6211, 92-2 USTC P 60,111 Alma M. O'REILLY, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. Charles H. O'REILLY, Sr., Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 1403

973 F.2d 1403

70 A.F.T.R.2d 92-6211, 92-2 USTC P 60,111

Alma M. O'REILLY, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

Charles H. O'REILLY, Sr., Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

Nos. 91-2004, 91-2009.

United States Court of Appeals,

Eighth Circuit.

Submitted Feb. 13, 1992.

Decided Sept. 1, 1992.

Jonathan S. Cohen, Dept. of Justice, Washington, D.C., argued (Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen and Teresa T. Milton, Dept. of Justice, on brief), for respondent-appellant.

James F. McLeod, Springfield, Mo., argued (Vincent Tyndall, on brief), for petitioner-appellee.

Before LOKEN, Circuit Judge, BRIGHT, Senior Circuit Judge, and HANSEN, Circuit Judge.

LOKEN, Circuit Judge.

The Commissioner of Internal Revenue appeals the Tax Court's decision that Charles and Alma O'Reilly owe no additional gift tax for the 1985 and 1986 tax years. The issue turns on the valuation of the O'Reillys' gifts of O'Reilly Automotive, Inc., stock in trust to their children. The Commissioner objected to the O'Reillys' use of a gift tax actuarial table to value their retained right to dividend income from the stock. The Tax Court upheld the taxpayers' use of the table. We reverse and remand.

I.

In May 1985, Charles and Alma each donated twenty shares of O'Reilly Automotive to five grantor retained income trusts, or GRITS as they are called by tax planners. Charles and Alma retained the right to all income during the two-to-four-year life of each trust, with the stock passing to their children at expiration. O'Reilly Automotive stock was then worth $9,639 per share. The O'Reillys' basis was $115 per share. In the three years prior to 1985, O'Reilly Automotive had paid dividends of $13 per share, a yield of 0.2%. ¹ To avoid paying substantial capital gains taxes, the trustee was authorized to hold the shares in each trust, free of any duty to seek greater income by diversifying.

Despite O'Reilly Automotive's history of paltry dividends, the O'Reillys valued their short-term retained income interests for gift tax purposes at twenty-five to thirty percent of the total value of the stock by using the gift tax actuarial table appearing in Treas.Reg. § 20.2512-5(f), Table B, which is based upon an assumed ten percent annual rate of return. The Commissioner determined that use of the actuarial table was inappropriate and assessed gift tax deficiencies for the years 1985 and 1986 based upon the full value of the stock at the dates of gift, $9,639 per share. The O'Reillys filed timely petitions with the Tax Court contesting the deficiencies.

In the Tax Court, the Commissioner argued that the gift tax applies to the entire value of the stock because the O'Reillys' retained income interest "is not susceptible of measurement on the basis of generally accepted valuation principles." Treas.Reg. § 25.2511-1(e). The O'Reillys argued that Treas.Reg. § 25.2512-5 requires the use of Table B to value both their retained income interests and the remainder interests gifted to their children.

The Tax Court ruled that the O'Reillys had properly used Table B. The Court acknowledged that taxpayers did not want the trustee to sell the stock, and that in the years prior to the gifts the stock had produced far less income than the ten percent return incorporated into Table B. However, the Court rejected the Commissioner's reliance on § 25.2511-1(e) because it "is directed toward situations where the gifts are subject to conditions which are not susceptible of valuation, such as death without issue, and not to situations where the gifts are unconditional but the underlying facts may cause the gift to be difficult to value." O'Reilly v. Commissioner, 95 T.C. 646, 650-51 (1990). The Court also distinguished four cases relied upon by the Commissioner ² because they involved gift tax exclusion issues under I.R.C. § 2503(b).

The Tax Court observed that, if the O'Reillys had given their children the income interests, rather than the remainders, the Commissioner's argument would result in no taxable gift, a result inconsistent with Treas.Reg. § 25.2512-5(d) and Rev.Rul. 79-280, 1979-2 C.B. 340. "In this context," concluded the Court, "the transfers should be treated as what they really were, namely, gifts of future interests in an amount equal to the discounted fair market value of the stock, determined under Table B, in accordance with the mandate of section 25.2512-5(d)." Id. at 654. This approach "will facilitate the valuation of gifts," "produces a realistic result and takes into account 'the interest of a simplified overall administration of the tax laws.' " Id. at 655, quoting McMurtry v. Commissioner, 203 F.2d 659, 666 (1st Cir.1953).

On appeal, the Commissioner argues that Treas.Reg. § 25.2511-1(e) should apply. Applying the rule of Robinette v. Helvering, 318 U.S. 184, 63 S.Ct. 540, 87 L.Ed. 700 (1943), the Commissioner claims that the O'Reillys' retained income interests cannot be valued under generally accepted valuation principles because the trusts held non-income-producing stock in a closely held family business and the trustee never intended to sell the stock and reinvest in property that would produce increased income. In any event, the Commissioner argues, taxpayers have the burden of establishing the value of their gifts, and actuarial Table B may not be used in this case because it produces a "patently unreasonable result."

II.

The gift tax applies to transfers of property in trust. I.R.C. § 2511(a). When the settlor of a trust retains a present or future interest in the property transferred to the trust, Treas.Reg. § 25.2511-1(e) provides:

§ 25.2511-1(e). If a donor transfers by gift less than his entire interest in property, the gift tax is applicable to the interest transferred.... However, if the donor's retained interest is not susceptible of measurement on the basis of generally accepted valuation principles, the gift tax is applicable to the entire value of the property subject to the gift.

The gift tax statute provides generally that gifts of property are taxed on the basis of the property's fair market value at the date of the gift. I.R.C. § 2512(a). See Commissioner v. Powers, 115 F.2d 209 (1st Cir.1940), aff'd, 312 U.S. 259, 61 S.Ct. 509, 85 L.Ed. 817 (1941); Heyen v. United States, 945 F.2d 359, 364 (10th Cir.1991). The subject is covered in greater detail in Treas.Reg. § 25.2512. The following portions of that regulation are critical in this case:

The General Principle.

§ 25.2512-1. ... The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.... All relevant facts and elements of value as of the time of the gift shall be considered.... See ... §§ 25.2512-4 through 25.2512-6 for further information concerning the valuation of other particular kinds of property.

The Relevant Specific Applications.

§ 25.2512-5(a)(1)(i). ... [T]he fair market value of annuities, life estates, terms for years, remainders, and reversions transferred after November 30, 1983, is their present value determined under this section.... Where the donor transfers property in trust or otherwise and retains an interest therein, the value of the gift is the value of the property transferred less the value of the donor's retained interest.

§ 25.2512-5(c). ... If the interest to be valued is the right to receive income of property or to use non-income-producing property for a term of years, column 3 of Table B is used.

§ 25.2512-5(d). ... If the remainder or reversion is to take effect at the end of a term for years, column 4 of Table B should be used.

The Table B referred to is the actuarial table used by the O'Reillys. It is found at subsection 25.2512-5(f). The O'Reillys used Column 3 of Table B to determine the portion of the stock's total value attributable to their retained income interests. Column 4 shows the reciprocal portion attributable to the remainder interests gifted to their children.

A.

We agree with the Tax Court that the O'Reillys' retained income interests were "susceptible of measurement on the basis of generally accepted valuation principles" within the meaning of Treas.Reg. § 25.2511-1(e). The parties stipulated to the total per share value of the stock. The company had a history of paying small but steady dividends in the years prior to the gifts. As Table B illustrates, the value of a term-of-years income interest can be actuarially determined using any assumed rate of return. Thus, on this record, we have little doubt that a valuation expert using "generally accepted valuation principles" could place a value on the retained income interests in question. ³ That value would no doubt be dramatically different than the value produced by use of Table B, but it would not be zero. In other words, the problem here is not that the value of the interests cannot be measured. It is that Table B produces a wildly unrealistic measurement.

A review of prior cases confirms that the last sentence in Section 25.2511-1(e) applies only to property interests subject to contingencies that are indeterminable and that make it more likely than not that the interests will have no value. For example, in Robinette v. Helvering, the taxpayer sought to deduct the value of a reversionary interest that would have value only if the grantor's thirty-year-old daughter had no child who reached the age of 21 and if neither life tenant distributed the remainder of the property by will. The Court concluded that "the actuarial art could do no more than guess at the value" of this negligible interest. 318 U.S. at 189. Likewise, in the gift tax exclusion cases cited in footnote 2, the taxpayer failed to introduce evidence that any income would be received by the trust beneficiaries. When...