Shepherd v. Commissioner of Internal Revenue

• Decision Date: 28 February 2002
• Docket Number: 0112250,11
• Parties: J. C. SHEPHERD, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.UNITED STATES COURT OF APPEALS FOR THE ELEVENTH CIRCUIT
• Court: U.S. Court of Appeals — Eleventh Circuit

J. C. SHEPHERD, Petitioner-Appellant v COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee

No. 01-12250

UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

February 28, 2002

Appeal from a Decision of the United States Tax Court Tax Court No. 2574-97

Before BLACK and HULL , Circuit Judges, and RYSKAMP¹, District Judge.

HULL, Circuit Judge:

This appeal involves the value, for federal gift tax purposes, of the transfer of minority shares of leased land by Petitioner J.C. Shepherd ("Shepherd") to his two adult sons through a family partnership. After trial, the United States Tax Court held that the transfer was an indirect gift of undivided fractional shares of land and that the value of the gift to each son was $160,876. Upon review and oral argument, we affirm the Tax Court's decision for the reasons explained in its opinion published at 115 T.C. 376 (2000).²

Rather than repeating what the Tax Court has already stated, we build on its observations and comment only on two issues discussed by our esteemed dissenting colleague: (1) whether the gift was properly characterized as one of interests in land instead of shares of the family partnership, and (2) whether a 33.5 percent discount is inapplicable when valuing the land gifted in this case.

I. . GIFT OF LAND

We agree with the Tax Court that the gift in this case was an indirect gift of land, and not partnership interests, for several reasons. First, the taxpayer himself initially reported the gift as one of land.³ Shepherd's 1991 gift tax return listed the gift as two undivided 25 percent interests in a "Leased Fee Estate" without assigning any discount amount. His first petition for review in the Tax Court also referred to the total gift as "an undivided one-half interest" in the acreage.

Second, and even more significantly, the Tax Court correctly interpreted the undisputed sequence of events here to conclude that Shepherd's sons already held their partnership interests when their father's deed of land became effective. Initially, Shepherd owned more than 9,000 acres of land subject to a long-term timber lease. On August 1, 1991, he executed an agreement intended to create the Shepherd Family Partnership, of which he would be the managing partner and 50 percent owner. Each son would have a 25 percent ownership interest. On August 1, Shepherd and his wife⁴ also executed two deeds transferring 100 percent of their interest in the land to this partnership. Shepherd's sons did not sign the partnership agreement until August 2.

As the Tax Court correctly observed, the Shepherd Family Partnership did not come into existence under Alabama law until August 2 when Shepherd's sons signed the partnership agreement. See Ala. Code § 10-8-2 (1994) (recognizing only "association of two or more persons" as valid partnership). Until that signing, there could be no "donee capable of taking the gift" or "acceptance of the gift by the donee," both of which must occur for a gift to be legally complete. Estate of Whitt v. Commissioner, 751 F.2d 1548, 1560-61 (11th Cir. 1985). Thus, the deed of land to the partnership dated August 1 was not effective until after the partnership had sprung to life on August 2.

Because the creation of the partnership (and its interests) necessarily preceded the effectiveness of the deed, "[w]hatever interests [Shepherd's] sons acquired in this property they obtained by virtue of their status as partners in the partnership." 115 T.C. at 387. And gifts to a partnership, like gifts to a corporation, are deemed to be indirect gifts to the stakeholders "to the extent of their proportionate interests" in the entity. See 26 C.F.R. § 25.2511-1(h)(1). Thus, instead of completing a gift of land to a preexisting partnership in which the sons were not partners and then establishing the partnership interests of his sons (which would result in a gift of a partnership interest), Shepherd created a partnership in which his sons held established shares⁵ and then gave the partnership a taxable gift of land (making it an indirect gift of land to his sons).

Third, the dissent, while not disputing these facts, contends that (1) "Shepherd's intent was to give his sons a partnership interest in family property," (2) he simply "utilized fewer steps in his attempt to create his sons' partnership interests" than if he had created a valid partnership with a second partner and then transferred the shares of the partnership to his sons, and (3) elevating form over substance here would compel "the unnecessary resort to the advise of tax lawyers prior to effectuating a simple transaction."

These arguments ignore that Shepherd himself reported the gift as land and also misperceive the crucial import of facts in both tax planning and the adjudication of tax disputes. See Frank Lyon Co. v. United States, 435 U.S. 561, 576 (1978) ("[A]s the Court has said in the past, a transaction must be given its effect in accord with what actually occurred and not in accord with what might have occurred."); Don E. Williams Co. v. Commissioner, 429 U.S. 569, 579-80 (1977) (stating that "while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not, ... and may not enjoy the benefit of some other route he might have chosen to follow but did not" and finding that clear facts prevented taxpayer's recharacterization of the events for tax purposes and request to "indulge in speculating how the transaction might have been recast with a different tax result") (quoting Commissioner v. National Alfalfa Dehydrating, 417 U.S. 134, 149 (1974)).⁶

II. VALUATION

Once the Tax Court accurately determined that the gift at issue was one of land, it properly valued this property for federal gift tax purposes. First, the Tax Court correctly focused its valuation inquiry on the moment between Shepherd's transfer of the land and his sons' receipt of their interests because the gift tax is "measured by the value of the property passing from the donor." Robinette v. Helvering, 318 U.S. 184, 186 (1943); 26 C.F.R. § 25.2511-2(a). This "in transit" valuation has been described as analyzing "the moment of truth, when the ownership of the [donor] ends and the ownership of the [donees] begins." United States v. Land, 303 F.2d 170, 172 (5th Cir. 1962).⁷ "Brief as is the instant [of transfer], the court must pinpoint its valuation at this instant." Id. See also Estate of Bright v. United States, 658 F.2d 999, 1002 (5th Cir. 1981) (en banc) (noting valuation for estate tax purposes "to be made at the time of the transfer").⁸

Second, applying this focus, the Tax Court correctly sought to "put [itself] in the position of a potential purchaser of the interest at that time" to find the fair market value. Land, 303 F.2d at 173. See also 26 C.F.R. § 20.2031-1(b) (defining value under the Internal Revenue Code as "the price at which the 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 the relevant facts"). Based on testimony from one of Shepherd's experts, the Tax Court applied a 15 percent valuation discount to the gift because of characteristics of the undivided fractional interests in land - the lack of complete control over the parcel, the risk of disagreement about disposition of the land and the possibility of partition of the land.⁹

Despite the urgings of both Shepherd and the dissent, the Tax Court properly did not seek to value the land by reference to the sons' ownership of the land through the partnership after transfer. To do so would have ignored the fact that the gift tax is not imposed on "what the donee receives." 115 T.C. at 385. Thus, the value of an indirect gift of a land interest does not depend on how the donee receives it, whether it is held in a partnership, fee simple, a corporate escrow account, a trust or any other method for holding property used by a donee. See Land, 303 F.2d at 172 ("It is a fallacy . . . to argue value before or after [the transfer] on the notion that valuation must be determined by the value either of the interest that ceases or of the interest that begins. . . . [T]he value of the interest before or after death is pertinent only as it serves to indicate the value at [transfer].").¹⁰ See also Estate of Watts v. Commissioner, 823 F.2d 483, 486 (11thCir. 1987) (noting that "the property to be valued . . . is that which the [donor] actually transfers . . . rather than the interest held by the [donor], or that held by the [donee]"); Bright, 658 F.2d at 1006 (rejecting factoring identity of parties into valuation methodology because "[i]t would be strange indeed if the estate tax value of a block of stock would vary depending upon the legatee to whom it was devised").¹¹

Although this calculation is necessarily hypothetical and often fact-intensive, it is not so difficult that the in-transit test "must give way to a more practical test to determine valuation" in this case, as the dissent urges. To do so would be to abandon this Court's carefully crafted taxation case law. Simply put, a potential purchaser of the land interest at the moment of transfer, with all relevant knowledge about the property in transit, would not be impacted by the happenstance that the recipients here were receiving it through a partnership.¹²

Finally, the Tax Court correctly held that a stipulation regarding an automatic 33.5 percent discount on the value of Shepherd's gift did not apply. Prior to trial, the parties entered into the following stipulation regarding the sons' minority partnership interests:

The parties agree that the correct minority and marketability discount for a 25 percent interest in the Shepherd Family partnership is 33.5 percent. This agreement relates only if the value of the gift(s) to the sons is measured by the sons' interests...