I’ve taken the title of one of Hemingway’s lesser novels as the theme of this post, because it illustrates what is necessary both to have not (in the case of Kenneth Lay’s annuity sale) and to have (in the case of the late Clyde Turner, Sr.). And why it is sometimes better to have not than to have.
Clyde’s story is told in Clyde W. Turner, Sr., Deceased, 2011 T.C. Mem. 209, filed 8/30/11. Clyde was a self-made millionaire, a World War II vet who went into the lumber business. Judge Marvel tells the Turner story at length, but cutting to the proverbial, Clyde Sr.’s daddy Ollie was the first depositor and pioneer stockholder in a little crossroads Georgia bank that grew into Regions Bank, mutated by phonetic transcription into Regents Bank, 2011 T.C. Mem. 209, at p. 40. Clyde Sr. got the stock, however you spell, it, bought more and never sold nuthin’ never.
Senior set up a life insurance trust for the benefit of his children and grandbabies, but paid the premiums himself, not out of trust assets. These, Judge Marvel ruled, were gifts of present interests, as the trust instrument provided that the children and grandbabies could demand present distributions, thus qualifying them for the annual gift exclusions. Even if the children and grandbabies never even knew they could demand present distributions, if they had the legal right to demand and receive, they had. Therefore the payments Senior made were gifts to them, even though they had not known that they had, and qualified for the annual gift exclusion, therefore Senior had not gift tax liability.
Unhappily for Senior’s heirs, son Marc hired some good ol’ boy lawyers from down the road to help Senior and Miss Jewell, his wife of nearly 60 years, plan for the inevitable. The lawyers put together an off-the-rack limited partnership, using a business agreement they drafted for someone else and adding the word “family” in places. The assets with which Senior and Miss Jewell funded the trust were all bank deposits and long-term buy-and-hold stock positions; though Senior had engaged in some real estate buying and selling, no such assets wound up in the LP.
Judge Marvel found that there was no non-tax business purpose to the creation of the LP. There was no need to centralize management of assets at risk of dissipation or which required special attention. There were no real risks of interfamilial litigation. All that the LP did was create a new bucket into which to drop whatever passive investments Senior had.
Thus, there was no bona fide sale of the assets Senior transferred to the LP, even though the heirs and IRS stipulated that Senior did receive full and adequate compensation in the form of the trust beneficial interests he got in exchange for the assets he contributed.
Moreover, Senior used the trust as an alternate bank account, paying himself a management fee though he did no work, and using the trust to make gifts to his children and commingled personal funds with trust corpus. And as sole general partner, he could amend the partnership agreement without consent of the limited partners.
Thus Senior had the trust corpus at date of death, and after paying estate taxes, his heirs had not as much as they thought they had.
Ken Lay, of Enron fame (or infamy), on the other hand, had not, during his lifetime, so no income tax due. This is the result Judge Goeke reaches in Estate of Kenneth L. Lay, Deceased, Linda P. Lay, Independent Executrix and Linda P. Lay, 2011 T.C. Mem. 208, filed 8/29/11.
While Ken was riding high at Enron, he made retirement noises. The Board, which Judge Goeke deemed independent, wanted to keep him, but Ken wanted spot cash free of tax. So the Board let Ken sell Enron an annuity he had bought from Manulife for a price within 5% of FMV, after much corporate formality, appraisals and complying with State law and the requirements of Manulife, and for no gain above his basis in the annuity contract. So Ken reported no gain in year of transfer.
IRS tried to make much of the fact that Manulife claimed it didn’t receive the originals of the assignments and didn’t change title on their books. No matter, says Judge Goeke. Enron treated the annuity as its own, listed it on the asset matrix in its bankruptcy petition, and faxed copies of all the transfer documents to Manulife. Both Enron and Ken fully performed under their written contract of sale. That Enron sent Ken an amended W-2, showing the sale proceeds as wages, years later, as part of a deal Enron made with IRS during the Enron bankruptcy, didn’t change an already fully consummated transaction.
Equitable title, benefits and burdens, is the test. Enron had, Ken had not. To prove this, Lovely Linda approached Manulife saying she wanted some cash, and asked for it. Manulife told her “no, nacho money.”
IRS tried the Section 83 gambit, that the “sale” was disguised payment of wages, as the annuity supposedly “sold” was not subject to substantial risk of forfeiture. By the terms of sale, if Ken wasn’t fired or quit before 4.25 years, he could get the annuity back from Enron. The sale was golden handcuffs, to keep Ken working for Enron and on the straight and narrow. If he didn’t stay, he wouldn’t get the annuity back. Nor was the annuity segregated or placed in trust, to prevent Enron’s creditors from seizing. So there was substantial risk of forfeiture.
Thus, no non-qualified deferred compensation plan.
So although Ken had $5 million from Enron, he had not a taxable gain.