Opinion · United States Tax Court
ESTATE OF du PONT, JR. v. COMMR. OF INTERNAL REVENUE, 63 T.C. 746 (1975)
ESTATE OF WILLIAM du PONT, JR., DECEASED, JEAN ELLEN du PONT McCONNELL,WILLIAM S. POTTER, & Del. Tr. Co., AS EXECUTORS, PETITIONERSv. Comm’r OF INTERNAL REVENUE, RESPONDENT, 63 T.C. 746 (T.C. 1975)
- Type
- Opinion
- Court
- United States Tax Court
- Jurisdiction
- Federal
- Date
- 1975-03-31
- Topic
- general
ESTATE OF du PONT, JR. v. COMMR. OF INTERNAL REVENUE, 63 T.C. 746 (1975) ESTATE OF WILLIAM du PONT, JR., DECEASED, JEAN ELLEN du PONT McCONNELL,WILLIAM S. POTTER, AND DELAWARE TRUST COMPANY, AS EXECUTORS, PETITIONERSv. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket No. 2926-70.United States Tax Court.
Citator
UpLaw has not yet analyzed ESTATE OF du PONT, JR. v. COMMR. OF INTERNAL REVENUE, 63 T.C. 746 (1975). The absence of a flag is not a finding that it is good law.
ESTATE OF du PONT, JR. v. COMMR. OF INTERNAL REVENUE,63 T.C. 746(1975)
ESTATE OF WILLIAM du PONT, JR., DECEASED, JEAN ELLEN du PONT McCONNELL,
WILLIAM S. POTTER, AND DELAWARE TRUST COMPANY, AS EXECUTORS, PETITIONERS
v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 2926-70.
United States Tax Court.
Filed March 31, 1975.
2. A corporation (Point Happy), wholly owned by another corporation (Shapdale) which itself was wholly owned by D, purchased real property from a stranger which it later leased to D for a term of 10 years with an option to renew for successive 10-year terms. The rental was a fair rental, based upon the fair market value of the property. D thereafter acquired all of Point Happy's stock from Shapdale and transferred it to an irrevocable trust in which he had no interest.Held,this was in the nature of an arm's-length arrangement in which D did not "retain" the "possession or enjoyment" of the property or any interest therein within the meaning of sec. 2036(a).
3. By his will, D's father created a testamentary trust in which the Delaware Trust Co. (the bank) was named trustee. Included in the trust's assets was a majority of the stock of the bank itself. To avoid a possible conflict of interest in voting its own stock, the bank entered into an arrangement whereby that stock was transferred to a newly created corporation (Hopeton) in exchange for Hopeton's nonvoting common stock; at the same time 10 shares of Hopeton's preferred stock possessing the sole voting power but only a nominal interest in the earnings and equity of the corporation were issued to D and his sister, the life beneficiaries of the testamentary trust. D subsequently acquired his sister's preferred stock.Held,the foregoing arrangement could not deprive the remaindermen of the testamentary trust of their right to receive their allocable interests in the bank stock, complete with voting power, and accordingly the voting control over the bank stock through ownership of the Hopeton preferred was limited to D's lifetime, with the consequence that in valuing the preferred stock in D's estate there must be excluded any element of value based upon control of the bank.
FINDINGS OF FACT
The parties have filed two stipulations of fact which together with their accompanying exhibits are incorporated herein by this reference.
William du Pont, Jr. (decedent), died testate on December 31, 1965, at the age of 69. Jean Ellen du Pont McConnell, William S. Potter, and the Delaware Trust Co. were duly appointed as executors of his will on January 4, 1966, by the register of wills for New Castle County, Del. At the time of filing the petition herein Jean Ellen du Pont McConnell resided in Greenville, Del.; William S. Potter resided in Wilmington, Del.; the Delaware Trust Co., a corporation, had its principal place of business in Delaware and its mailing address in Wilmington, Del. The executors filed a Federal estate tax return with the district director of internal revenue at Wilmington, Del. In that return, the executors elected to use the alternate valuation date of December 31, 1966.
1.The Hall, Inc., property. — Upon the death of his father in 1928, decedent inherited certain real estate known as Bellevue Hall upon which his father had resided in Brandywine Hundred, New Castle County, Del. Decedent continued to own Bellevue Hall through 1960, at which time it consisted of slightly less than 261 acres. In addition to a number of residential and recreational buildings, the property, which was located in Delaware's so-calledPage 749"horse belt," included extensive facilities devoted to training racehorses.
On or about June 30, 1961, Hall, Inc., a Delaware corporation, was organized. Shortly thereafter, on September 21, 1961, decedent conveyed approximately 242 acres of Bellevue Hall to Hall, Inc., in exchange for all of Hall, Inc.'s issued and outstanding capital stock, amounting to 100 shares. At all times relevant herein, this tract of land and the improvements thereon (Hall, Inc., property) comprised Hall, Inc.'s only substantial asset. The 18.46-acre pocket of Bellevue Hall which decedent retained was surrounded on three sides by the Hall, Inc., property and on the fourth side by a public road. It does not appear that the Hall, Inc., property was artificially set off from the remainder of Bellevue Hall, such as by a fence or the like. Nor does the record show that Bellevue Hall did not continue to give the appearance of a single estate.
On the 18.46-acre portion of Bellevue Hall which decedent did not convey to Hall, Inc., stood his principal residence, an 18-room mansion. Among the other buildings on that retained land was a sports building, equipped with a swimming pool, badminton court, two tennis courts, and an underground passage to the mansion. A third building, the "Playhouse," adjacent to an outdoor swimming pool, contained a living room, kitchen, and two dressing rooms. Also within the portion of property retained by decedent were three greenhouses, a ham house, and two cape cod style cottages each with six or seven rooms.
The Hall, Inc., property was devoted largely to activities involving horses and the training of racehorses. It was dominated by a 1 1/4-mile oval dirt horserace track. Adjacent to the track was the main race barn, containing 23 stalls, feed room, oat room, hospital room, office with washroom, and bedroom and bath for the caretaker. The other facilities included 14 lesser barns, an indoor racetrack of frame and corrugated metal construction, a jockey house, several sheds, 4 garages one of which enclosed 16 stalls, a farmhouse, and 7 cottages each typically having a living room, dining room, kitchen, 2 or 3 bedrooms, and a bath. In addition there was a kennel, a 2 1/2-story creamery building, a duck and turkey house, and a number of other buildings for assorted purposes.
All of the Bellevue Hall improvements, including those of the Hall, Inc., property, were well cared for. A series of macadam andPage 750gravel roads ran throughout Bellevue Hall, connecting the improvements of both portions. The land itself was well graded and landscaped. Apart from the separation of title as between the Hall, Inc., property and the retained 18.46 acres, the record fails to show that both parcels, known in the aggregate as Bellevue Hall, consisted of anything other than a single, integrated property, devoted to the residential, recreational, and other possible uses of the decedent.
On September 28, 1961, 1 week after conveying the Hall, Inc., property to the corporation decedent and Hall, Inc., entered into a lease whereby he leased the property from it. The lease was what local real estate people referred to as a "net net lease," whereby the lessee, decedent, assumed responsibility for all of the expenses associated with the use of the property, including inter alia the costs of all maintenance, repairs, utilities, insurance, and the entire amount of any taxes, assessments, or other charges for revenue to which the property might be subject. The term of the leasehold was 10 years, commencing October 1, 1961, during which period the annual rental was $8,700. At the expiration of the initial term and each succeeding term, if any, the lessee was entitled to renew the lease for an additional 10-year term at an annual rental to be agreed upon or, failing in that, to be set by appraisers appointed at that time.
At the time of the conveyance of the Hall, Inc., property and execution of the lease in 1961 the highest and best use thereof as well as of the entire Bellevue Hall estate was for residential subdivision purposes and, to the extent permitted by zoning limitations, for commercial development. The rental provided in the lease was based in part, at least, upon a valuation of the property calculated upon the assumption that it was to be used as "horse farm" rather than upon its substantially higher fair market value (at least three to four times as much) based upon its highest and best use. It was unlikely that an owner of such property, having in mind its substantially higher fair market value for real estate development purposes, would have tied it up by lease in an arm's-length transaction for a period as long as 10 years at a rental based upon its use as a horse farm, coupled with an option to renew for successive 10-year periods at rentals to be agreed upon.
At times after entering into the lease, decedent continued to use the Hall, Inc., property as a racehorse training farm. DuringPage 751the remainder of his life, decedent paid the annual rental and fulfilled the terms of the lease. At the time of his death, the lease was still in effect, and his estate continued to perform the obligations as lessee until September 30, 1971.
At all times prior to January 2, 1962, decedent owned 100 percent of the issued and outstanding capital stock of Hall, Inc. On January 2, 1962, approximately 3 months after entering the aforementioned lease, decedent irrevocably transferred all of the stock of Hall, Inc., in trust to the Delaware Trust Co. Despite being sole trustee, the Delaware Trust Co.'s power to sell or vote the Hall, Inc., stock was subject to the written consent of two "advisers," Jean Ellen du Pont McConnell, decedent's daughter, and William S. Potter, decedent's attorney and close friend. During the decedent's lifetime, the trustee was required to accumulate any income and add it to corpus. Upon his death, his widow became an income beneficiary; and in the event he was not survived by a widow, or upon her subsequent death, provision was made for distribution of income and principal to his descendants. He retained no interest in the trust as a beneficiary, life tenant, remainderman, or trustee, nor could any interest in the corpus revert to him. Decedent filed a Federal gift tax return for the year 1962 on which he reported the aforementioned transfer. He reported the fair market value of the gift at $1,138,137 and paid the gift tax thereon. The return was closed on survey by the Internal Revenue Service.
In June 1965, Hall, Inc., sold five small parcels of land, a total of .542 acres of the Hall, Inc., property, to decedent for $5,420, at a reported gain of $5,139.01.
As of December 31, 1966, the fair market value of the Hall, Inc., property was $1,680,700. On decedent's Federal estate tax return, the Hall, Inc., property was not included in the gross estate. In his notice of deficiency the Commissioner determined that "the value of real estate leased to the decedent by Hall, Incorporated is includable in the taxable estate * * * pursuant to Section 2036 of the Internal Revenue Code."
2.The Point Happy, Inc., property. — Point Happy, Inc. (Point Happy), a California corporation, was organized on April 6, 1953. At that time all of its outstanding stock was issued to Shapdale, Inc. (Shapdale), a Delaware corporation wholly owned by decedent, in return for $1,000. From that date until April 20, 1961, Shapdale owned all of Point Happy's issued andPage 752outstanding stock during which time decedent, likewise, continuously owned all of Shapdale's stock.
Shortly after its incorporation, Point Happy acquired from someone other than decedent about 72 acres of land in the Coachella Valley, Riverside County, Calif., and the improvements thereon for $12,500. This land (including improvements made both before and after such acquisition) is sometimes referred to herein as the "Point Happy property" or the "property." It is located about 15 miles southeast of the city of Palm Springs and at all times relevant herein was the only substantial asset of Point Happy. The property is situated in a desert region with good subterranean water sources rendering it suitable for the cultivation of citrus fruits (principally grapefruit) and dates. Due in part to a rocky ridge running the length of the property, though, nearly half of it was agriculturally unusable. At the time that Point Happy purchased it, the arable portion of the property was already improved as a date ranch. Subsequently, Point Happy planted young grapefruit trees interspersed among the date palms. However, during this period the economic importance of agriculture in the area surrounding the Point Happy property had decreased markedly as the area's resort industry burgeoned and land prices rose sharply. By March 1960, new date and grapefruit groves were no longer being planted.
During the period ending on April 20, 1961, Point Happy made substantial improvements to the property in addition to the introduction of grapefruit trees. The corporate records reveal expenditures of $190,279.16 charged to the land account prior to 1961 and exclusive of the purchase price. Of this amount, $166,724.02 was spent as follows:
Waterlines and water system ................. $85,035.33
Roads ......................... 45,085.30
Citrus ........................ $23,521.83
Fencing ....................... 13,081.56
As of March 1960, the property included three old, but restored, dwellings, a garage, a stable, four storage sheds, and a fenced-in tennis court as well as a paddock and generally very attractive landscaping. Altogether during this period, Point Happy spent $353,272.09 for the property and related fixed assets (e.g., buildings and improvements, machinery and equipment, electric lines, and tennis courts). During the succeeding yearPage 753Point Happy built a main residence on the property at a cost of $26,000.
From April 6, 1953, through the year 1960 Point Happy received loans from both Shapdale, its parent corporation, and decedent, resulting in the following cumulative debts:
Date Owed to decedent Owed to Shapdale
Dec. 31, 1956 ........... $3,659.36 $78,150.85 Dec. 31, 1957 ........... 3,659.36 175,318.26 Dec. 31, 1958 ........... 3,659.36 273,065.11 Dec. 31, 1959 ........... 3,659.36 338,961.48 Dec. 31, 1960 ........... 3,659.36 379,996.27
In the years 1957 through 1960 it sustained a net loss each year; its total income for the entire period was $3,087.57, and its expenses (exclusive of depreciation) exceeded its income by $28,111.90. In March of 1961 Point Happy was indebted to Shapdale in the amount of $377,593.38, which Shapdale then contributed to the capital of Point Happy.
Dec. 31, 1956 ........... $3,659.36 $78,150.85 Dec. 31, 1957 ........... 3,659.36 175,318.26 Dec. 31, 1958 ........... 3,659.36 273,065.11 Dec. 31, 1959 ........... 3,659.36 338,961.48 Dec. 31, 1960 ........... 3,659.36 379,996.27
On March 12, 1961, decedent entered into a lease with Point Happy whereby he leased the Point Happy property in return for an annual rent of $9,000 plus 20 percent of the net profits derived by the lessee from any business conducted on the property. The rental was based upon an assumed fair market value of $100,000 for the property, as determined by an independent appraiser. The term of the lease was 10 years commencing April 1, 1961, with the lessee granted the right to renew the lease for additional 10-year terms at an annual rental to be agreed upon with the lessor. The lease was what, in the real estate vernacular of southern California, is referred to as a "net net lease," one by which the lessor was freed from all expenses associated with the property other than the amount of taxes, assessments, and other "charges for revenue" to which the property was subject at the outset of the leasehold term. The only other exception concerned the water used on the premises, the facilities for which the lessor was obligated to maintain. The record fails to show to what extent, if at all, decedent resided on or made use of the Point Happy property either before or after the signing of the lease.
Decedent fulfilled the terms of the lease until the time of his death, after which his estate continued to perform the obligations as lessee. During the years 1961-65, Point Happy's only gross income (except for a comparatively minor item in 1965 of an undisclosed nature) was the $9,000 annual rental paid byPage 754decedent as lessee. It sustained a net loss of over $4,000 in each of 4 of those years and a net loss of over $2,000 in the fifth; however, if depreciation deductions were not taken into account, it realized a profit or cash flow for each year ranging from some $1,700 to almost $5,000. During the time that decedent was lessee of the Point Happy property, he made substantial expenditures with respect to the property, including the construction of one or two more dwellings thereon.
On April 20, 1961, some 40 days after decedent leased the property, Shapdale sold all of the stock of Point Happy to decedent for $100,000. On June 20, 1961, decedent irrevocably transferred all of the Point Happy stock in trust to the Delaware Trust Co. The trust instrument was substantively very similar to the instrument by which he later transferred the Hall, Inc., stock,supra;although the Delaware Trust Co. was the sole trustee, its power to sell or vote the stock was conditioned upon the approval of two "advisers," Jean Ellen du Pont McConnell and William S. Potter. Decedent retained no interest in the trust as beneficiary, life tenant, remainderman, or trustee, nor could any interest in the corpus revert to him. Decedent thereafter timely filed a Federal gift tax return in respect of the transfer, the fair market value of which he reported as $100,000. This return was closed on survey by the Internal Revenue Service.
On February 27, 1970, Point Happy sold all of the Point Happy property to a third party for $375,000. On decedent's Federal estate tax return, the Point Happy property was not included in the gross estate. In his notice of deficiency, the Commissioner determined that "the value of real estate leased to the decedent by Point Happy, Incorporated is includable in the taxable estate * * * pursuant to Section 2036 of the Internal Revenue Code." The parties have stipulated that if it is determined that the value of the property is properly includable in decedent's gross estate, the amount to be reported is $315,000, the value as of December 31, 1966, the alternate valuation date.
3.The Hopeton Holding Corp. preferred stock. William du Pont, Sr., decedent's father, died January 20, 1928. His last will and testament left the residue of his estate in trust with the Delaware Trust Co. (Delaware Trust), designated as the sole trustee of the estate and executor of the will. Included among the assets of William du Pont, Sr.'s residuary estate were 5,825 shares of the capital stock of Delaware Trust representing 58.25Page 755percent of its issued and outstanding stock. Delaware Trust was, at all times relevant, a State-chartered bank engaged in the banking and trust business in Delaware and a member of the Federal Deposit Insurance Corp.
William du Pont, Sr.'s will directed the trustee to pay six specified annuities and further directed the trustee to pay the net income of the trust estate, not necessary to pay the six annuities, in a ratio of 40 percent to his daughter, Marion du Pont Somerville (Scott), and 60 percent to his son, William du Pont, Jr. (decedent herein), during the terms of their natural lives. Upon the death of either William, Jr., or Marion leaving a living child or issue of a deceased child, the trustee was directed to distribute to all of William, Sr.'s grandchildren or descendants of deceased grandchildren that portion of the principal (60 or 40 percent) allocable to William, Jr., or Marion, as the case might be (subject proportionately, however, to the payment of the specified annuities). In the event that either Marion or William, Jr., should die leaving no surviving descendants, the trustee was directed to pay all of the net income (not required for the specified annuities) to the survivor of the two, and, upon the death of the survivor to distribute the entire trust estate (subject to the payment of the annuities) to all of William, Sr.'s then-living grandchildren and the living issue of any deceased grandchild. Provision was also made for other disposition of the principal in the event that both Marion and William, Jr., died without being survived by any living children or issue of any deceased child.
At a meeting of the board of directors of Delaware Trust Co. on January 30, 1928, the board was advised that there was some question as to whether it could vote its own shares of stock held in its capacity as an executor or trustee; if it could not, control of the bank would be in the hands of minority stockholders, or at least n the hands of incumbent management for an indefinite future. The directors, therefore, adopted a resolution, on January 30, 1928, the substance of which was proposed by decedent and his sister, to exchange the shares of Delaware Trust stock owned by the estate of William du Pont, Sr., for a like number of shares of a new corporation formed for this purpose, the voting control of which would not reside with Delaware Trust. By its terms, this resolution was contingent upon decedent and his sister providing Delaware Trust, its officers, and its directors a bond of indemnityPage 756against any loss or damage which it or they might incur by reason of the transfer.
On February 2, 1928, Hopeton Holding Corp. (Hopeton), a Delaware corporation, was formed. Hopeton's charter restricts the business of the corporation to "purchase, take, own, hold, sell, exchange, transfer, or otherwise dispose of shares of the capital stock of Delaware Trust Company." The total authorized capital stock of Hopeton, has, at all relevant times, been 5,835 shares, without par value, of which 10 shares are preferred stock and the balance common stock. Under the certificate of incorporation the preferred stock is entitled to full voting rights at all meetings of the corporation; the common stock has voting privileges only with respect to any amendment or alteration to the certificate of incorporation, the creation of any corporate debt or liabilities, or the sale, transfer, exchange, or other disposition of any shares of capital stock of the Delaware Trust Co. The certificate of incorporation also provides that the preferred stock is to be paid a fixed dividend of $1 per share per year, before any dividends shall be paid on the common stock, and that the preferred stock shall not participate in any additional earnings or profits. Neither Hopeton's certificate of incorporation nor its bylaws state the dissolution rights of the capital stock of Hopeton. However, the January 30, 1928, resolution by the Delaware Trust board of directors expressly contemplated that the holders of Hopeton's preferred stock would be entitled upon dissolution to receive $1 per share before any distribution to the holders of the common stock.
On February 6, 1928, decedent and his sister, Marion du Pont Somerville, executed the bond of indemnity called for in the January 30, 1928, resolution of the board of directors of Delaware Trust; the amount of the bond was $900,000. As of December 31, 1927, Delaware Trust's total resources were valued at $9,729,367.43; its book value was $1,379,627.71. At about this time, the 10,000 issued and outstanding shares of Delaware Trust had a value of $150 per share, or approximately $1,500,000 in the aggregate.
Shortly after Hopeton was formed, its common stock (5,825 shares) was issued to Delaware Trust as trustee under the will of William du Pont, Sr., in exchange for an equal number of shares of Delaware Trust's capital stock which represented 58.25 percent of Delaware Trust's issued and outstanding capital stock.Page 757The capital stock of Delaware Trust was set up as an asset on the books of Hopeton at $100 per share, which was the par value of Delaware Trust's shares. A corresponding amount was credited to capital attributable to the common stock of Hopeton. At about the same time the Hopeton preferred stock (10 shares) was issued for $10 per share, which was paid. Six of the shares were issued to decedent and four to his sister, Marion du Pont Somerville (Scott). Shortly thereafter decedent received by gift from his sister the 4 shares of Hopeton preferred stock originally issued to her. Thereafter, and until November 9, 1954, decedent was the owner of all 10 shares of the Hopeton preferred stock. The balance sheets of Hopeton, including that of December 31, 1966, reflect a liability account entitled "Assessment-Preferred Stock" in the amount of $1,400, which, when added to the $100 paid in cash, amounts to $1,500 shown in the capital account in respect of the preferred stock.
On November 9, 1954, decedent transferred his 10 shares of Hopeton's preferred stock to a newly created trust, naming Marion du Pont Somerville (Scott), Jean Ellen du Pont McConnell, William S. Potter, and himself as trustees, and reserving to himself as grantor an unconditional power of revocation. At termination the trust fund was to be distributed to the decedent if living; if not, to such of his descendants then living as a majority of the trustees should deem "best qualified to receive and administer" the trust fund. Income of the trust was to be paid to decedent's daughter, Jean Ellen du Pont McConnell, for her life and thereafter in equal shares per stirpes to the decedent's descendants, until the trust would terminate. Among the specific powers given to the trustees of this trust was the power to sell, publicly or privately, or exchange, or otherwise dispose of all property held in the trust fund, real or personal, for such price and upon such terms as the trustees thought proper. When decedent died the 10 shares of Hopeton preferred stock were still held in this trust.
At the time of decedent's death, on December 31, 1965, Hopeton still owned 58.25 percent of the Delaware Trust's issued and outstanding stock, although as a consequence of various stock splits, Hopeton then owned 116,500 shares of Delaware Trust's 200,000 then outstanding shares (58.25 percent). At the time of his death, decedent owned 18,100 shares of Delaware Trust stock (9.05 percent) which he bequeathed to Hopeton, thereby raisingPage 758its total holding to 67.30 percent of Delaware Trust's outstanding shares. The balance of Delaware Trust's shares (32.70 percent) was publicly held by approximately 450 shareholders. Consequently, from 1928 until at least the time of trial herein, Hopeton has owned a majority of Delaware Trust's voting stock and with it the power to elect the board of directors. The holder of the 10 shares of Hopeton's preferred, in turn, had the power, through his voting control of Hopeton, to dictate the composition of the board of directors of Delaware Trust. Shortly after decedent's father's death in 1928 and upon the transfer of the 5,825 shares of Delaware Trust to Hopeton, there was a change in management of Delaware Trust whereby decedent became the president in place of the incumbent. He also became chairman of the board at a later time and held both offices until his death. He had been a director as early as 1922 and similarly retained that position until death. During the years 1961-65, decedent and his sister were president and vice president, respectively, of Hopeton and were members of its board of directors. Decedent's daughter Jean was the only other director in 1961, and she and William S. Potter (decedent's friend and attorney) were the only other directors during 1962-65.
The shares of Delaware Trust have been at all times the only substantial asset of Hopeton. For example, on both December 31, 1965, and December 31, 1966, the only other assets of Hopeton were $164.02 in cash plus 16 shares of du Pont 4 1/2-percent preferred stock having a market value of $1,734.12. The fair market value of Delaware Trust stock on December 31, 1966, was $115 per share, i.e., the bid price on December 30, 1966, and January 3, 1967, was $115 per share and there were no asked prices. Measured by that value, and without taking into account blockage and other factors, the 200,000 shares outstanding were worth approximately $23 million in the aggregate. For 1966, Delaware Trust reported to its shareholders annual gross income of $9,589,185, net earnings of $1,585,803 or $7.92 per share, and book value of $47.81 per share, up from $40 in 1965. At the yearend, its total resources were $141,654,392 and its net worth was $9,562,851.
In every year since 1928, the common stockholders of Hopeton have received a dividend in an amount substantially equivalent to (but slightly less than) the dividends received by Hopeton from Delaware Trust which, for example, in 1966, wasPage 759approximately $20 per share. The preferred stockholders of Hopeton have annually received a dividend of $1 per share since 1942; during the 14 years prior to that time, the preferred shareholders had received only a single, cumulative dividend of $13.75 per share in 1941.
When William du Pont, Jr., died in 1965, he was survived by five children: Jean Ellen du Pont McConnell, Evelyn du Pont Donaldson, W. Henry du Pont, John Eleuthere du Pont, and William du Pont III. These five children were and are the only grandchildren of William du Pont, Sr.; Marion du Pont Somerville (Scott) survives without issue, and is now about 80 years old.
Pursuant to the terms of the testamentary trust of William du Pont, Sr., the children of William du Pont, Jr., were each entitled to receive one-fifth of 60 percent of the trust estate (subject to the payment of 60 percent of certain annuities), upon the death of William du Pont, Jr., and, accordingly, on March 28, 1966, Delaware Trust, as trustee under the will of William du Pont, Sr., distributed to each of the grandchildren of William du Pont, Sr., and in the case of William du Pont III (who was a minor) to his guardians, all of the cash and securities due them, including 60 percent of the Hopeton common stock, amounting to 699 shares each (20 percent x 60 percent x 5,825 shares).
On August 4, 1972, W. Henry du Pont, a son of the decedent, and beneficiary under the will of William du Pont, Sr., commenced an action against Delaware Trust and Hopeton in the Delaware Court of Chancery, alleging that the Delaware Trust willfully committed a breach of its fiduciary responsibility to the intended beneficiaries of William du Pont, Sr.'s last will and testament by exchanging the Delaware Trust stock for Hopeton's common stock. W. Henry du Pont's prayer for relief requested the Court of Chancery (1) to compel Delaware Trust Co. and Hopeton to deliver to him such number of shares of Delaware Trust Co. as he is entitled to receive under the will of William du Pont, Sr., upon his surrender of the shares of Hopeton Holding Corp. common stock which were distributed to him on March 28, 1966, following the death of his father; (2) to enjoin defendants from transferring or encumbering any of the stock of Delaware Trust Co. or Hopeton; and (3) to remove Delaware Trust Co. as trustee under the will of William du Pont, Sr.Page 760
The remaining four issue of William du Pont, Jr., and his sister, Marion du Pont Somerville (Scott), filed a Motion to Intervene as defendants in the action brought by W. Henry du Pont, which motion was granted. All defendants denied the allegations of the complaint respecting the Hopeton exchange, and asserted several affirmative defenses. The litigation has been conducted in a wholly adversary manner.
On August 9, 1972, Delaware Trust notified the executors of decedent's estate and decedent's sister of the suit instituted by W. Henry du Pont and informed them that claims would be made against them under the bond of indemnity executed by decedent and his sister on February 6, 1928, at the time of the exchange of Delaware Trust stock for Hopeton stock.
On September 17, 1973, the Delaware Court of Chancery granted defendants' motion for summary judgment and denied plaintiff's motion for summary judgment. However, this decision was reversed by the Supreme Court of Delaware on April 16, 1974.W. Henry du Pont v. Delaware Trust Co., et al.,320 A.2d 694(Del. 1974), rehearing denied (May 13, 1974). The Supreme Court of Delaware noted that while the Hopeton-Delaware Trust stock exchange had preserved the income and growth features of the Delaware Trust shares, it had nonetheless severed the voting rights from the corpus, thereby enabling William, Jr., to perpetuate voting control in Hopeton beyond the time of his own death through the creation of the 1954 voting trust. Since it was clearly the intention of William, Sr., that both the equity and voting components of the Delaware Trust stock be distributed beginning with the death of either life tenant, the Supreme Court held that the lower court had accorded insufficient attention to the lack of protection provided for the remaindermen, included among whom was W. Henry du Pont, the plaintiff.1For this reason the court remanded the matter to the Court of Chancery for the purpose of fashioning relief which will provide the plaintiff with his intended portion of Delaware Trust voting power improperly withheld after the death of William, Jr.Page 761
At the time of decedent's death, the 10 shares of Hopeton preferred stock continued to be held by the revocable trust created by decedent in 1954.
On decedent's Federal estate tax return, the executors of the estate did not include the value of the Hopeton preferred stock, reported as $100, in decedent's gross estate but instead listed the stock in Schedule G as a lifetime transfer not includable in decedent's estate. In his notice of deficiency, the Commissioner determined that —
the fair market value of 10 shares of preferred stock of Hopeton Holding Company [sic] is $6,553,032.94 in lieu of $100.00. It is further determined that the value of these shares which were transferred in trust is includable in the taxable estate pursuant to Sections 2036 and 2038 of the Internal Revenue Code.
OPINION
(a)Hall, Inc. — Insofar as the Hall, Inc., property is concerned, the relevant sequence of events is as follows: Decedent organized Hall, Inc., a corporation owned entirely by him, to which he then transferred the "horse farm" portion of Bellevue Hall, a residential estate also owned by him. Shortly thereafter he leased the property from Hall, Inc., for a term of 10 years with an option to renew for successive 10-year periods. The rental was not based upon the fair market value of the property — its highest and best use being for real estate development — but was correlated to a much lower figure (between a third and a fourth of the fair market value of the property) based upon its use as a "horse farm." He then transferred without reservation the entirety of Hall, Inc.'s stock to a newly created trust for the benefit of his offspring. At issue is whether decedent's leasehold interest in that portion of Bellevue Hall held by Hall, Inc., amounted in substance to such retention of the property as would require its inclusion in his gross estate by reason of section 2036(a)(1) of the Internal Revenue Code, the pertinent portion of which follows:Page 762
SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.
(a) GENERAL RULE. — The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death —
(1) the possession or enjoyment of, or the right to the income from, the property, or
It is the Commissioner's contention that inasmuch as decedent in fact had both the possession and enjoyment of all of Bellevue Hall continuously from times prior to the transfer of the property to Hall, Inc., and the creation of the trust until the time of his death, he literally "retained * * * the possession or enjoyment" of the Hall, Inc., property for a period which did "not in fact end before his death." In support of his position, the Commissioner argues that the lease through which decedent retained possession vastly understated the property's true rental value, an indication that the entire arrangement lacked substance.
Petitioners respond that the only property relevant to the operation of section 2036(a)(1) is thestockof Hall, Inc., all of which decedent transferred to the trust without retaining any residual use or enjoyment thereof whatsoever. Alternatively, in respect of the real estate which decedent transferred to Hall, Inc., petitioners maintain that decedent subsequently reacquired possession solely by virtue of the payment of a fair market rent under the lease, and that such apurchasedinterest overrides and thereby precludes the existence of aretainedinterest as contemplated by section 2036(a)(1). We, however, are persuaded that in the circumstances of this case decedent did in substance retain a life estate (or interest which did not in fact end before his death) described by section 2036(a)(1) in the Hall, Inc., property.
Section 2036, the statutory descendant of section 811(c)(1)(B) of the 1939 Code, embodies a policy of comprehensive estate taxation directed at those lifetime transfers which are "essentially testamentary — i.e., transfers which leave the transferor a significant interest in or control over the property transferred during his lifetime."United States v. Estate of Grace,395 U.S. 316,320. See alsoUnited States v. O'Malley,383 U.S. 627,630-631;Guynn v.United States,437 F.2d 1148,1150Page 763(C.A. 4);Estate of Harry H. Beckwith,55 T.C. 242,247. The broad language of the statute operates to increase the decedent's gross estate by the inclusion of the value of property which has been the subject of an inter vivos transfer whenever the decedent has "retained" an interest in the property and "the ultimate possession or enjoyment of which is held in suspense until the moment of the decedent's death or thereafter."Goldstone v. United States,325 U.S. 687,691, quoted inCommissioner v. Estate of Church,335 U.S. 632,646, and inMcNichol's Estate v. Commissioner,265 F.2d 667,673(C.A. 3), affirming29 T.C. 1179, certiorari denied361 U.S. 829. The Supreme Court, in applying section 811(c)(1)(B) of the 1939 Code, strictly circumscribed the type of transfer which can escape the reach of that section.Commissioner v. Estate ofChurch,335 U.S. at 645-646:
an estate tax cannot be avoided by any trust transfer except by a bona fide transfer in which the settlor, absolutely, unequivocally, irrevocably, and without possible reservations, parts with all of his title and all of his possession and all of his enjoyment of the transferred property. After such a transfer has been made, the settlor must be left with no present legal title in the property, no possible reversionary interest in that title, and no right to possess or to enjoy the property then or thereafter. In other words such a transfer must be immediate and out and out, and must be unaffected by whether the grantor lives or dies. * * *
It is apparent to us that on the facts before us decedent's undisturbed enjoyment of the Hall, Inc., property until the time of his death is irreconcilable with the type of unqualified transfer demanded by section 2036(a)(1).
The altogether evident fact on this record is that Bellevue Hall, both prior and subsequent to the creation of Hall, Inc., comprised a single, integrated property used for residential, recreational,2and possibly other purposes. Notwithstanding decedent's attempt to carve out what was ostensibly a residential enclave in the midst of his family's estate, there can be little doubt that the entirety of Bellevue Hall continued to serve as his residence with its related facilities. There is nothing in the record to suggest otherwise, and every reasonable inferencePage 764confirms that decedent's enjoyment of Bellevue Hall in toto continued unabated until the time of his death.
Our understanding of decedent's relationship to and enjoyment of Bellevue Hall (inclusive of the Hall, Inc., portion) is incompatible with a conclusion that, by a series of title conveyances alone, decedent could remove a part of Bellevue Hall from his gross estate. It is axiomatic in matters of taxation generally, and particularly with respect to intrafamily arrangements of the sort before us, that the law must respond to the operative effect of a transaction regardless of its form; the simple passage of legal title to a trustee does not necessarily constitute a transfer which can survive the careful scrutiny demanded by section 2036(a)(1).Commissioner v. Estate of Church,335 U.S. 632,644. Cf.UnitedStates v. Estate of Grace,395 U.S. 316,323;In Re Estate ofBomash,432 F.2d 308,311(C.A. 9), reversing50 T.C. 667;Skinner's Estate v. Commissioner,316 F.2d 517,520(C.A. 3);Estate of Marie J. Nicol,56 T.C. 179,182;Estate of EmilLinderme, Sr.,52 T.C. 305,309.
Upon consideration of the whole record, we are firmly convinced that the series of legal steps, beginning with the creation of Hall, Inc., on June 30, 1961, and concluding with the transfer of its stock in trust on January 2, 1962, comprised a single device, wholly lacking in substance, by which decedent attempted to divest himself of title to the property without relinquishing his possession or enjoyment thereof. This is, of course, not to say that had decedent conveyed the property to Hall, Inc., and then leased a separate but similar piece of property in its stead, such leased property would necessarily be includable in his gross estate. But here we are considering a unique piece of property which, in conjunction with decedent's principal residence, comprised a single, integrated unit, the possession of which property he had enjoyed for years past and the lease for which he negotiated with his wholly owned corporation — a lease so structured that it hardly reflected the kind of bona fide transaction that would have been entered into by parties dealing with one another at arm's length. The independently appraised value of the property, assuming its highest and best use for a combination of residential subdivision and commercial enterprise, was approximately $1,200,000. We have very little doubt that an independent owner would have been completelyPage 765unwilling to enter into such a comparatively long-term lease the rent for which was predicated upon its substantially diminished value as a "horse farm." Indeed, one of petitioner's valuation experts admitted that he, as owner, would not have entered such a lease without a clause permitting him to terminate it prior to its natural expiration. We do not suggest that an owner of property suitable for real estate development would not enter into a bona fide lease at a rental based upon a considerably lower fair market value in an effort to salvage as much as he can prior to the exploitation of the property for its highest and best use. The vice in the arrangement before us is that the "salvage" rental based on the substantially lower fair market value of the property as a "horse farm" is coupled with a lease term that tied up the property at that rental and for that purpose for a period of years beyond that which would be acceptable in a bona fide transaction without a termination clause. We are fully satisfied that in the circumstances of this case the lease cannot be treated as a bona fide arrangement at a fair rental, and that our view of the substance of what is before us must not be obscured by that lease. Moreover, the substance is clear: The decedent continued to have the possession and enjoyment of the entire Bellevue Hall estate (including the Hall, Inc., property) for a period which did not in fact end before his death, thus bringing this case within the terms of section 2036(a)(1).
The Supreme Court's decision inUnited States v. Byrum,408 U.S. 125, to which petitioners direct our attention, is wholly inapposite in the circumstances of this case. There the decedent, who owned a majority of the shares of stock of three corporations (which had a substantial number of unrelated minority stockholders) irrevocably transferred in trust a portion thereof (less than 50 percent of the outstanding shares in each corporation) but retained the voting rights in such transferred shares. In the case of two of the corporations his voting rights in the shares not transferred when combined with the retained voting rights in the transferred shares exceeded 50 percent, and in the case of the third corporation his voting rights in the shares not transferred alone exceeded 50 percent. The Court held that the mere retention of the majority voting rights in the circumstances of that case did not of itself bring it within the scope of section 2036(a)(1) solely on account of the corporate control which thus remained with the decedent. The instant casePage 766presents quite a different kind of situation. By reason of our evaluation of the evidence in the present case, we have disregarded the arrangement with Hall, Inc., which we have found to be lacking in bona fides, and we therefore do not need to consider the hypothetical effect of interposing a corporation with a different arrangement between decedent and his residential estate.3Accordingly, our view of decedent's arrangement with Hall, Inc., undercuts entirely the significance of factors otherwise thought to indicate the existence of a transfer to which section 2036(a) is inapplicable. Thus, it is quite beside the point that decedent paid some, albeit inadequate, "rent" to Hall, Inc., or that decedent paid money for the reconveyance of title to a small portion of the property. The Hall, Inc., property, along with the remainder of Bellevue Hall, continued to be available to decedent continuously until his death for residential, recreational, and other purposes. This is precisely the situation to which section 2036(a)(1) speaks, on account of which we hold that the value of the Hall, Inc., property is includable in decedent's estate.
(b)Point Happy. — While the facts surrounding the Point Happy property resemble those relating to the Hall, Inc., property, they differ in several key respects. The decedent himself never owned the Point Happy property. Shapdale, decedent's wholly owned corporation, formed Point Happy which thereupon purchased the property, a date ranch, from an unrelated party. About 10 years later Point Happy leased the property to decedent, but unlike the Hall, Inc., lease the rental appears to have been based upon the full fair market value of the property. Shortly thereafter, Shapdale sold the Point Happy stock to decedent, whereupon he transferred it to a newly created trust for the benefit of his offspring. As in the case of the Hall, Inc., property, the issue here concerns the applicability of section 2036(a)(1) to the property, and the parties' respective positions parallel those assumed in respect of that issue. Although the result is not free from doubt, we are satisfied that a decision in favor of petitioner is warranted.
Despite the similarity of the Point Happy and Hall, Inc., arrangements, the differences are significant. Unlike the BellevuePage 767Hall situation, decedent had no connection with the property whatsoever prior to its purchase by Point Happy. Furthermore, the record is wholly silent as to whether decedent thereafter occupied the property or used it otherwise for vacation, recreation, or other personal purposes. Nor is there any evidence that the property was used differently after the execution of the lease than it had been prior thereto. Moreover, it appears from all the evidence that the lease bore a fair rental, based upon the opinion of an independent appraiser. And while the 10-year term with an option to renew for successive like periods is troublesome, it is more reasonable than in the case of the Hall, Inc., property since the rental here represented an adequate return on the fair market value of the property. We find — although without strong confidence — that the lease is one which adverse parties acting at arm's length might have entered into.
Accordingly, we are not inclined to hold that decedent "retained * * * the possession or enjoyment of" the Point Happy property (or an interest therein) for a period which did not in fact end before his death. Rather it appears that by transferring the Point Happy stock to the trust decedent completely divested himself of all interest, direct or indirect, in the property, retaining none of the taxable incidents of ownership. This is not altered by the existence of the lease, which displays the earmarks of a bona fide transaction of the sort adverse parties might enter into. In the absence of any evidence tending to establish the unique value of the property to decedent, the situation strikes us as most like that which would have existed had decedent completely divested himself of his direct or indirect interest in the Point Happy property and then rented another similar piece of property. Certainly in that case there would be no question of estate taxation, and we are satisfied that a like result is proper here. We conclude that the value of the Point Happy property is not includable in decedent's estate.
2.Hopeton Holding Corp. preferred stock. — At the outset, we find it helpful to summarize the facts giving rise to this issue. Decedent's father, William du Pont, Sr., died on January 20, 1928, and by his will left the bulk of his estate, including 5,825 shares of Delaware Trust stock, in trust with Delaware Trust. The 5,825 shares represented 58.25 percent of its outstanding stock. After the payment of certain annuities not important here, the trustee was directed to distribute the net income of the trustPage 768to William du Pont, Sr.'s son (decedent herein) and daughter in amounts equaling 60 and 40 percent, respectively. Upon the death of each life tenant, his or her respective portion was to be distributed "in equal shares, to and among all my grandchildren who may then be living and the issue then living of any deceased grandchild of mine."
On account of certain difficulties occasioned by Delaware Trust's role as trustee of a majority of its own stock, it was shortly thereafter arranged for the trust to exchange the 5,825 shares of Delaware Trust stock for an equal number of nonvoting common shares of Hopeton, a corporation to be created for this purpose. The voting control of Hopeton (and, hence, of Delaware Trust) was vested in 10 shares of preferred stock with minimal equity interest, 6 of which shares were distributed directly to decedent and 4 to his sister. She thereafter gave her shares to decedent. This arrangement effectively divorced the equity interest in Delaware Trust, which the Hopeton common represented, from the voting control which resided with decedent in the form of the Hopeton preferred stock.
In 1954 decedent placed all 10 voting shares of Hopeton preferred stock in a revocable trust, to continue until 20 years after the death of certain of his grandchildren unless terminated earlier by the trustees. At the time of decedent's death, all 10 shares of Hopeton preferred were still held in trust. Upon termination, the trustees are required to deliver the Hopeton voting shares free of trust "unto such of the Trustor's descendants then living as a majority of the then acting Trustees, in their uncontrolled discretion, shall deem to be best qualified to receive and administer the assets then comprising the trust fund."
Since the 1954 trust was revocable, there is no dispute that any property transferred to it by the decedent, of which he had the power of disposition, is properly includable in his gross estate.4The issue litigated by the parties was the fair market value ofPage 769that property — i.e., the 10 shares of Hopeton preferred. And the principal, if not the only, matter in dispute was the extent to which, if any, that fair market value should reflect an element of value to be attributed to the control over Delaware Trust as a result of the voting power inhering in the Hopeton preferred. The valuation experts at the trial differed widely as to the effect that such control would have upon the fair market value of the Hopeton preferred. However, we need not make any finding in this respect, because we are convinced by petitioner's alternative argument that, whatever control the decedent may have had during his lifetime over Delaware Trust through his ownership of the Hopeton preferred, he had nothing in respect of such control that he could have disposed of at his death (or, for that matter, prior to his death) to the disadvantage of the remaindermen of the trust established under the will of his father, William du Pont, Sr.
By the terms of their father's will, decedent and his sister were entitled to receive the income from the trust assets held by Delaware Trust (subject to the specified annuities) for the duration of each of their lives. During that period it was necessarily contemplated that the Delaware Trust stock would remain as a single block in trust. It is equally evident from the requirement that the trust's corpus be distributed upon the death of each income beneficiary that William du Pont, Sr., did not intend that his children's interest therein extend beyond their lives. Clearly decedent and his sister received no more than life estates in the Delaware Trust stock, at the conclusion of which the remaindermen, their children, were entitled to receive it in its entirety.
At the risk of belaboring the obvious, we must stress that, as life tenants, decedent's, as well as his sister's, entire interest in the Delaware Trust stock absolutely terminated upon each of their deaths. And absent the concurrence of the remaindermen, no agreement with the trustee, including the Hopeton exchange, could expand their interests beyond death at the expense of the remaindermen. Thus, whereas the Hopeton exchange itself may well have been within the authority of the trustee, decedent's interest in the Hopeton preferred stock, to the extent that he controlled the voting rights of the 5,825 shares of Delaware Trust stock, was nonetheless that of a life tenant. As such he had the power to make neither a testamentary disposition thereof nor anPage 770inter vivos transfer for a period in excess of his own life. Obviously, this conclusion was not altered by decedent's unilateral action of placing the Hopeton preferred stock in a revocable trust the life of which extends beyond his own death. Decedent's entire interest in the control over Delaware Trust reflected in the rights conferred by the Hopeton preferred stock and, likewise, the interest of the 1954 revocable trust to that extent ended with his death on account of which the Hopeton preferred possessed no value in respect of such control includable in decedent's gross estate.
Even if we were less sure of our conclusion in this respect than we are, the nature of the decedent's rights has been authoritatively determined in an adversary proceeding by the Supreme Court of Delaware inW. Henry du Pont v. Delaware TrustCo.,320 A.2d 694(Del. 1974), rehearing denied (May 13, 1974), and its decision in this connection must be accepted by us as binding. A "State's highest court is the best authority on its own law."Commissioner v. Estate of Bosch,387 U.S. 456,465. The litigation in the Delaware courts has been recounted in our findings and need not be restated here. By its decision the Supreme Court of Delaware in effect held that any benefits inhering in the Hopeton preferred stock to the extent of control over Delaware Trust passed at the decedent's death to the remaindermen of the trust created by William du Pont, Sr., the decedent's father. In substance, in respect of the Hopeton preferred, the decedent had nothing over which he had the power of disposition that could affect the control over Delaware Trust after his death. His right of control existed only during his lifetime, and that right was no greater than that of a life tenant, which for that reason is plainly not includable in his gross estate. See Rev. Rul.66-86, 1966-1 C.B. 216. We decide this issue for petitioner.
Since there did not appear to be any real dispute between the parties as to the value of the Hopeton preferred when stripped of any power of control over Delaware Trust, we will not assume that, apart from any such element of control, they will be unable to agree upon a value for the stock in theDecision to be entered under Rule 155.Page 771
- The court noted, inter alia, that the indemnity bond given by decedent and his sister in 1928 did not cure the detriment. "The bond cannot buy voting rights and the difficulty in attempting to measure the market value of Hopeton common compared to unrestricted Delaware Trust voting stock is so manifest as to discourage the attempt." ↩
- In using the term "recreational" we do not necessarily include the training of racehorses, nor do we mean to pass upon the question whether the training of racehorses constituted the conduct of a "trade or business" as distinguished from a "hobby." Plainly, however, it may fairly be inferred that the activity was one from which decedent derived personal satisfaction and which he found it convenient to be carried on adjacent to his residence and various recreational facilities. ↩
- Estate of Roy D. Barlow,55 T.C. 666, also relied upon by petitioner, is distinguishable. That case turned upon its special facts and the Court's treatment of the rental there involved as a "fair rental." We do not find that the rental in the context of the facts of this case was "fair," and we reach a different conclusion here on a quite different record. ↩
- SEC. 2038. REVOCABLE TRANSFERS.
(a) IN GENERAL. — The value of the gross estate shall include the value of all property —(1) TRANSFERS AFTER JUNE 22, 1936. — To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished in contemplation of decedent's death.
↩