Just Fill In the Blanks

This is the story of the late Dr. Sheldon C. Sommers, physician and art-lover, and his less-than-happy family, wife Bernice, and nieces Wendy, Julie and Mary Lee. Doc Shel had an art collection literally to die for, and he did. But before departing this vale of tears, Doc Shel gifted (or maybe not) his precious collection to the nieces aforesaid, via interests in a limited liability company created for the purpose.

Doc Shel had been married to Bernice but divorced her before he started the LLC. His only blood relatives were the nieces aforesaid. He had the paperwork done, but there were blanks therein, and thereby hangs the tale of Estate of Sheldon C. Sommers, Deceased, Bernice Lang Sommers, Executrix, Petitioner, and Wendy Sommers, Julie Sommers Neuman, and Mary Lee Sommers-Gosz, Intervenors, 2013 T. C. Memo. 8, filed 1/10/13, with Judge Halpern as our docent.

“These consolidated cases arose as a result of two notices of deficiency issued to petitioner in January 2007. One notice determined gift tax deficiencies of $245,733 and $209,723 for 2001 and 2002, respectively. The other determined an estate tax deficiency of $542,598. The gift tax deficiencies (challenged by petitioner in docket No. 9305-07) are premised on respondent’s position that, in reporting as taxable gifts decedent’s December 27, 2001, and January 4, 2002, transfers of LLC units to the nieces (2001 and 2002 transfers), a position which petitioner now rejects as improper, petitioner undervalued those units for Federal gift tax purposes.” 2013 T. C. Memo. 8, at p. 4.

So why is Bernice here? Well, after Doc Shel divorced her and gifted (or didn’t) the artwork to the nieces aforesaid, he and Bernice remarried, after which Doc Shel died, fewer than the three magic years after the gift (or non-gift). Doc Shel, at the time of the gift (or non-gift), was a resident of the State of Indiana, home of raconteurs George Ade, Ernie Pyle and Jean Shepherd.

His Indiana counsel set up the LLC, Doc Shel signed over the artworks, including but not in any way in limitation of the generality of the foregoing, as the high-priced lawyers say, a few by Bernard Buffet, Charles Burchfield, Alexander Calder, Salvador Dali, Edward Hopper, and Joan Miro.

Standard operating procedure is to create LLC as a special purpose entity, ringed round with a moat of operating agreement provisions to prevent sale, dispersal or falling into hands of deadbeat spouses, profligate offpsring or their multiplex creditors. Now to get the LLC interests out of Doc Shel into the hot little hands of the nieces aforesaid without incurring gift tax.

“Decedent then would make gifts to the nieces, over a period of time, of his interests in it. The attorneys explained to decedent that, if the artwork was owned by a limited liability company, subsequent gifts of minority interests in it would have a lower value than gifts of the artwork itself because the recipients could not freely resell the interests and would lack control of it.” 2013 T. C. Memo. 8, at p. 9.

In other words, minority interest discount and limited scope of sale would decrease the FMV of the individual interests each niece aforesaid got. And the artwork was already spread out among the residences of the nieces aforesaid.

Because the unified credit was scheduled to increase over two years, Doc Shel and his advisers decided to split the gifts. “The idea was for decedent to give the nieces, in 2001, LLC units in an amount not to exceed his “basic exclusion amount” ($675,000) plus the three $10,000 annual exclusions then available. He then would transfer any remaining value (in the form of LLC units) in 2002 or in a later year.” 2013 T. C. Memo. 8, at p. 9. In the later years, he hoped to use the annual exclusion amounts, as they increased.

Okay, but as it wasn’t known in Year One (2001) what was the worth of the art, the documents left the percentages of LLC interests blank in the assignments, to be filled in when they got the appraisal.

They got the appraisal in 2002. There was good news and bad news. First the good news: the appraisal was way higher than Doc Shel or his advisers expected. Their reaction would have looked great on Antiques Roadshow. The bad news: the basic exclusion amount was way low, the annual exclusions a joke, so much gift tax would follow.

So the assignment of LLC interests was amended in 2002 to provide that the nieces aforesaid would pick up whatever gift tax wasn’t basically or annually excluded. And the blanks were filled in with the percentage interests each was getting.

Then, you remember, Doc Shel remarries Bernice, and dies. Bernice is Doc Shel’s sole legatee and executrix. The good news–Bernice gets everything. The bad news–everything includes a thwacking great estate tax bill, as the Indiana appraisal was way low, and gifts inside the three-year curtain are included in the estate.

Bernice wants either the gifts canceled and her marital exclusion boosted thereby, or the nieces to eat the enhanced gift tax and estate tax based on the true value if they get to keep the gifts.

In the meantime, Bernice and the nieces aforesaid battle it out in an Indiana arbitration (Bernice loses; arbitrator finds Doc Shel surrendered dominion and control in Year One notwithstanding blank spaces in the assignment), which the Indiana intermediate appellate court affirms. Then Bernice goes to New Jersey (Doc Shel moved from Indiana to New Jersey when he remarried Bernice, and died there) and tries her luck in their courts, but strikes out there as well. The advisers were dual agents for Doc Shel and the nieces aforesaid; all they did was fill in the blanks.

Not a whit dismayed, Bernice claims in Tax Court that Federal law is different, collateral estoppel and issue preclusion don’t work, whether the Indiana or the New Jersey variety.

After much palaver, Judge Halpern finds “Petitioner is collaterally estopped by both the Indiana and New Jersey decisions from arguing (1) that the 2001 and 2002 gifts were not gifts for Federal gift tax purposes and (2) that, in making those gifts, decedent retained a section 2038(a)(1) power to ‘alter, amend, revoke, or terminate’ those gifts until that power was relinquished on April 11, 2002.” 2012 T. C. Memo. 8, at pp. 42-43.

Bernice makes much over the blank spaces in the assignment, claiming these showed Doc Shel could have altered, amended, etc., the gift. No, says Judge Halpern: “We interpret the 2001 and 2002 gift documents in the context of the overall agreement among decedent and the nieces, which was for him to give his LLC units to them free of any obligation on his part to pay gift tax. On December 27, 2001, and January 4, 2002, the actual number of LLC units that decedent could transfer on those dates, free of gift tax, was unknown because the parties had not yet received the … valuation. The parties agreed, however, that once they had received the … valuation the blank LLC share amounts would be filled in on the basis of that valuation. Thus, the blanks manifested the parties’ intent to have [advisor] complete the gift documents consistent with their agreement that decedent give his LLC units to the nieces free from Federal gift tax. The parties’ intent with respect to the blanks was to have [advisor] carry out the terms of the original agreement, not to grant decedent the right to alter, amend, revoke, or terminate it. When the … valuation came in higher than expected, [advisor] advised the nieces that both prongs of their agreement with decedent could not be realized because decedent could not transfer all of his LLC units and still avoid gift tax; i.e., the 2002 gift would be subject to tax. The nieces and [advisor] were able to preserve the terms of the original agreement by having the nieces agree to pay the 2002 gift tax associated with the 2002 gift (a solution to the problem that had been discussed during the nieces’ initial meeting with [advisor]), and the original 2002 gift document was modified to reflect that undertaking on the part of the nieces. That modification and the other (nonsubstantive) modifications to the 2001 and 2002 gift documents carried out the parties’ original agreement; they did not alter or amend it.

“In essence, filling in the blanks was to be a ministerial act of completing, not revising or abandoning, the terms of the parties’ original agreement. The one substantive change that did occur (the nieces undertaking to pay any gift tax) was required and previously contemplated as a means of satisfying the one condition that had been built into the original agreement: that decedent not be subject to gift tax. That change enabled decedent to give all, rather than a portion, of his LLC units to the nieces, tax free, just as the parties intended.” 2013 T. C. Memo. 8, at pp. 44-46 (footnote omitted).

So it’s time to try the valuation of the art, and who must pay what by way of estate tax and gift tax.