Wheeler v. U.S.

• Decision Date: 19 June 1997
• Docket Number: No. 96-50144,96-50144
• Citation: 116 F.3d 749
• Parties: -5075, 97-2 USTC P 60,278 John Michael WHEELER, Independent Executor of the Estate of Elmore K. Melton, Jr., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 749

116 F.3d 749

80 A.F.T.R.2d 97-5075, 97-2 USTC P 60,278

John Michael WHEELER, Independent Executor of the Estate of Elmore K. Melton, Jr., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 96-50144.

United States Court of Appeals Fifth Circuit.

June 19, 1997.

Harry W. Wolff, Jr., Cox & Smith Incorporated, San Antonio, TX, Stanley M. Johanson, Vinson & Elkins, Houston, TX, for Plaintiff-Appellant.

Charles Bricken, Gilbert S. Rothenberg, Gary R. Allen, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC, for Defendant-Appellee.

Appeal from the United States District Court for the Western District of Texas.

Before GARWOOD, BARKSDALE and DENNIS, Circuit Judges.

GARWOOD, Circuit Judge:

This case involves the determination of the federal estate tax due from the estate of Elmore K. Melton, Jr. (Melton). On July 13, 1984, Melton, then age sixty, sold to his two adopted sons, John Wheeler and David Wheeler, the remainder interest in his ranch located in Bexar County, Texas. Melton retained a life estate in the ranch and used the actuarial tables set forth in the Treasury Regulations to determine the price to be paid by the Wheelers for the remainder interest. On May 25, 1991, Melton, then age sixty-seven, died. Melton's federal estate tax return did not include any value for the ranch. The Internal Revenue Service (IRS) issued a notice of deficiency, claiming that the sale of the remainder interest in the ranch to the Wheelers for its actuarial value did not constitute adequate and full consideration, and that accordingly the fair market value of the full fee simple interest in the ranch, less the consideration paid by the sons, should have been included in Melton's gross estate. The court below agreed and, following a line of cases stating that the sale of a remainder interest for less than the value of the full fee simple interest in the property does not constitute adequate consideration for the purposes of section 2036(a) of the Internal Revenue Code, determined that Melton's estate had been properly assessed an additional $320,831 in federal estate tax. We reverse.

Facts and Proceedings Below

I.

In the mid-1970s, Melton, who was born April 16, 1924, and never married, adopted two children, John Wheeler (John), who was born in 1956, and David Wheeler (David), who was born in 1958. Following their graduation from college, both sons----John in 1979, David in 1981----were employed by The Melton Company, a corporation of which Melton was then sole shareholder, president, and chairman of the board.

From 1983 until his death in 1991, Melton engaged in a series of financial transactions with his sons that the government contends had significant estate tax ramifications. On May 19, 1983, Melton gave John and David each 195 shares of The Melton Company common stock, representing approximately 16.2 percent of the 1204 shares outstanding. On June 30, 1984, The Melton Company, pursuant to a recapitalization plan, converted each share of existing common stock into one share of voting stock and three shares of nonvoting stock, denominated Class A and Class B shares respectively. On July 13, 1984, some three months after he turned 60, Melton gave John and David each 223 shares of Class B stock of The Melton Company.

Also on July 13, 1984, Melton executed a warranty deed conveying to John and David his 376-acre ranch, located in Bexar County, Texas. The deed reserved to Melton a life estate in the ranch. ¹ For many years prior to the sale, and until the time of his death Melton used the ranch as his personal residence. John and David paid for the remainder interest with a personal liability real estate lien note in the amount of $337,790.18, secured by a vendor's lien expressly retained in the deed and additionally by a deed of trust on the ranch. The deed and deed of trust were promptly recorded. The purchase price for the remainder interest in the ranch was determined by multiplying the sum of the appraised fair market value of the ranch's fee simple interest, $1,314,200, plus $10,000, by 0.25509, the factor set forth in the appropriate actuarial table in the Treasury Regulations for valuing future interests in property where the measuring life was that of a person of Melton's age. See Treas. Reg. § 25.2512-5(A).

On February 12, 1985, the initial note, which bore interest at the rate of 7 percent and called for annual payments of at least $10,000 principal plus accrued interest, was revised to provide for monthly payments of $833.33 principal plus accrued interest, which remained at 7 percent. ² On that date, John and David paid the amount due under the revised terms.

On October 18, 1985, Melton gave John and David each an additional 344 shares of Class B stock of The Melton Company.

In December 1986, Melton gave $10,000 each to John and David by forgiving that amount of each son's indebtedness under the note. On December 23, 1986, John and David received bonuses from The Melton Company of $50,000 and $55,000, respectively. Each son used $35,000 of his bonus to reduce the principal owed on the note to Melton. John and David each paid income taxes on their bonus. On December 29, 1986, Melton assigned the note to The Melton Company in partial payment of an existing debt that he owed the company.

One year later, on December 24, 1987, Melton gave John and David each forty more shares of Class B stock of The Melton Company. On December 26, 1987, Melton gave each son another 106 shares of Class A stock and 299 shares of Class B stock.

On January 28, 1988, both John and David received a 1987 year-end bonus of $250,000 from The Melton Company. They each paid income taxes on their bonus. On January 29, 1988, Melton sold to John and David each 280 shares of Class B stock of The Melton Company. John and David paid the remaining balance due on the note the same day. Throughout the course of the indebtedness under the note, John and David had continued to make monthly payments. The Melton Company continued to make annual, year-end bonuses to both John and David long after the note was retired.

On December 25, 1989, nearly two years after the note had been paid in full, Melton gave John and David each thirty-five shares of Class B stock of The Melton Company. As a result of these gifts, on December 26, 1989, Melton owned fifty percent of the Class A stock of The Melton Company and no Class B stock. John and David each owned twenty-five percent of the Class A stock and fifty percent of the Class B stock. The ownership structure remained fixed at these levels until Melton's death.

Melton died testate on May 25, 1991, at the age of sixty-seven, more than six years after the sale of the remainder interest to the Wheelers and more than three years after the note had been paid in full. The cause of death was heart failure. Melton had suffered from coronary artery disease and arteriosclerosis for approximately ten years. The undisputed evidence, however, was that Melton's death was not (and was not thought to be) imminent in July 1984 when he sold the remainder interest to the Wheelers (nor is there any evidence that it was ever imminent before 1991).

Melton's will and codicil were admitted to probate and John was appointed the independent executor of the estate. John timely filed an estate tax return reporting a gross estate of $581,106, and an estate tax liability of $199,936 (which was tendered with the return). The gross estate, as reported on the return, did not include any amount for the ranch, thus reflecting the estate's position that Melton had no interest in the ranch at his death.

The IRS subsequently issued its "Report of Estate Tax Examination Changes," taking the position that, under sections 2036(a) and 2043(a) of the Internal Revenue Code (IRC or Code), ³ the Melton estate should have included in the gross estate the difference between the date-of-death value of the ranch, $1,074,200, ⁴ and the consideration paid by the sons for the remainder interest, $337,790.18 (treated by the IRS as $338,000). Accordingly, the IRS determined that an additional $736,200 ($1,074,200 less $338,000) should have been included in the gross estate for the ranch. As a result, the IRS issued an estate tax notice of deficiency in the amount of $320,831. The Melton estate paid the asserted deficiency and filed a timely claim for refund. When the IRS did not allow the refund within the prescribed six months, the Melton estate commenced the instant action in the United States District Court for the Western District of Texas, San Antonio Division, seeking a refund of the additional estate tax assessed and paid, plus interest.

II.

Before the district court, the parties stipulated to the facts as set forth above and agreed to resolution of the issues by crossmotions for summary judgment. In its motion, the government contended that the series of transactions between Melton and his sons were part of a testamentary plan designed to shield most of the estate from taxation. The Melton estate argued that a sale of a remainder interest for its actuarial value comes within the "bona fide sale for an adequate and full consideration" exception to section 2036(a) and therefore the ranch was properly excluded from the gross estate.

The magistrate judge issued a report recommending that the government's motion be granted. The district court, without any discussion or explanation, overruled the estate's objections to the magistrate judge's report, accepted, approved, and adopted all the magistrate judge's findings and conclusions, and entered judgment for the government.

The magistrate judge, observing that the "classic case" envisioned by section 2036(a) was "a purported gift with a retained life estate in the donor," rejected the Melton estate's contention that the sale of the remainder interest in the ranch for its actuarial value constituted a "bona fide sale for adequate and full...