“Sadly, the result in Nelson is correct. The value was to be determined by their appraiser, not as finally determined for federal estate and gift tax purposes. The moral of this story: those ten missing words (as finally determined for federal estate and gift tax purposes) must be in every defined value transaction document!!! It’s unclear whether the Nelsons engaged separate counsel for the trust, which always is advisable.”

We close the week with commentary from Paul Hood on Nelson v. Commissioner. Members who wish to learn more about this important development can watch Paul and Bob Keebler discuss the implications of the Nelson case in their exclusive LISI Webinar titled “Nelson v. Commissioner – The Next Chapter in Protective/Defined Value Gift and Sale Clauses - A devastating loss for the Taxpayer.” For more information simply click this link: Paul/Bob.

L. Paul Hood, Jr. received his J.D. from Louisiana State University Law Center in 1986 and Master of Laws in Taxation from Georgetown University Law Center in 1988. Paul is a frequent speaker, is widely quoted and his articles have appeared in a number of publications, including BNA Tax Management Memorandum, CCH Journal of Practical Estate Planning, Estate Planning, Valuation Strategies, Digest of Federal Tax Articles,

Loyola Law Review, Louisiana Bar Journal, Tax Ideas and Charitable Gift Planning News. Presently, He has spoken at programs sponsored by a number of law schools, including Duke, Georgetown, NYU, Tulane, Loyola (N.O.) and LSU, as well as many other professional organizations, including AICPA and NACVA. From 1996-2004, Paul served on the Louisiana Board of Tax Appeals, a three-member board that has

jurisdiction over all Louisiana state tax matters. Paul is co-author with Steve

Leimberg of The Tools & Techniques of Estate Planning, The Tools & Techniques of Trust Planning and Tools & Techniques of Charitable Planning, which are published by The National Underwriter. His e-mail address is paul@paulhoodservices.com.

Here is Paul’s commentary:

EXECUTIVE SUMMARY:

In this 22-page gift tax Tax Court memorandum opinion, issued on June 10,

2020, Judge Pugh ruled in favor of the IRS on an attempted defined value gift and a defined value sale, holding that the donors transferred

percentage interests instead of specific dollar amounts, distinguishing Wandry. The court also determined the value of the percentage gift and the percentage sale, which resulted in a deficiency for both transactions. The case is appealable to the Fifth Circuit.

FACTS:

The issues for decision in Nelson were: (1) whether the interests in

Longspar Partners, Ltd. (Longspar), transferred by gift on December 31,

2008, and January 2, 2009, transferred by installment sale, were of fixed dollar amounts or percentage interests and (2) the fair market values of those interests.

Longspar was formed on October 1, 2008, as a Texas limited partnership based in Midland, Texas. It was formed as part of a tax planning strategy to (1) consolidate and protect assets, (2) establish a mechanism to make gifts without fractionalizing interests, and (3) ensure that WEC remained in business and under the control of the Warren family. Mr. and Mrs. Nelson are Longspar's sole general partners, each holding a 0.5% general partner interest (together holding a 1% interest in Longspar as general partners) and 99% as limited partners.

The biggest asset of Longspar was a 27% interest in a holding company that in turn held the stock of several operating subsidiaries, the business of which was primarily in two areas: oil field service and being the dealer of Caterpillar in just about the entire state of Oklahoma and much of west Texas.

Just three months after its formation, Mrs. Nelson made two transfers of limited partner interests in Longspar to a trust. The first transfer was a gift

on December 31, 2008. The Memorandum of Gift and Assignment of

Limited Partner Interest (memorandum of gift) provides:

[Mrs. Nelson] desires to make a gift and to assign to * * * [the Trust] her right, title, and interest in a limited partner interest having a fair market value of TWO MILLION NINETY-SIX THOUSAND AND NO/100THS DOLLARS ($2,096,000.00) as of December 31, 2008 * * *, as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment.

Petitioners structured the second transfer, on January 2, 2009, as a sale. The Memorandum of Sale and Assignment of Limited Partner Interest (memorandum of sale) provides:

[Mrs. Nelson] desires to sell and assign to * * * [the Trust] her right, title, and interest in a limited partner interest having a fair market value of TWENTY MILLION AND NO/100THS DOLLARS ($20,000,000.00) as of January 2, 2009 * * *, as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment * * *.

Neither the memorandum of gift nor the memorandum of sale contained clauses defining fair market value nor subjecting the limited partner interests to reallocation after the valuation date. In connection with the

second transfer, the trust executed a promissory note for $20 million (note).

Mr. Nelson, as trustee, signed the note on behalf of the trust. The note provides for 2.06% interest on unpaid principal and 10% interest on matured, unpaid amounts, compounded annually, and is secured by the limited partner interest that was sold. Annual interest payments on the note were due to Mrs. Nelson through the end of 2017. The Longspar partnership agreement was amended on January 2, 2009 (the date of the installment sale to the trust) to reflect the trust as the holder of a 6.14% limited partnership interest in Longspar (acquired by gift) and a 58.65% limited partnership (acquired by sale).

The Nelsons retained an appraiser to value the Longspar interests that

were given and sold. That appraiser in turn relied upon another appraisal of the operating companies that were included within the holding company

that in turn 27% of the stock of which was held in Longspar. The valuation issues aren’t that unusual, except to note that the appraisers for both the Nelsons and the IRS weren’t really that far apart. The real issue was the efficacy of the defined value clauses in the gift and in the sale.

Longspar reported the reductions of Mrs. Nelson's limited partner interest and the increases of the Trust's limited partner interests on the Schedules K-1, attached to its Forms 1065, U.S. Return of Partnership Income, for

2008 through 2013. Longspar also made a proportional cash distribution to

its partners on December 31, 2011. The Trust's portion of the cash distribution — 64.79% — was based on the appraiser's valuation.

The Nelsons filed separate Forms 709, United States Gift (and Generation- Skipping Transfer) Tax Returns, for 2008 and 2009. On their 2008 Forms

709, they each reported the gift to the trust “having a fair market value of

$2,096,000 as determined by independent appraisal to be a 6.1466275%

limited partner interest” in Longspar. They classified it as a split gift and

reported that each person was responsible for half ($1,048,000). They did not report the January 2, 2009, transfer of the Longspar limited partner interest on their 2009 Forms 709, consistent with its treatment as a sale.

With respect to the defined value clauses, the Nelsons relied upon Wandry v. Commissioner (covered by Paul Hood in Steve Leimberg’s Estate Planning Newsletter 1941, by Steve Akers in 1946 and by Gassman et al. in 1978) and Succession of McCord v. Commissioner, a Fifth Circuit decision (discussed in Steve Leimberg’s Estate Planning Newsletters 547,

551, 555, 557, 1010, 1016 and 1017). The IRS countered that the Nelsons actually gave and sold percentage interests in Longspar and not defined

value transfers.

Petitioners and the Internal Revenue Service (IRS) Office of Appeals (IRS Appeals) negotiated a proposed settlement agreement, but it was never completed.

On the basis of their settlement discussions with IRS Appeals, petitioners amended Longspar's partnership agreement to record the Trust's limited partner interest in Longspar as 38.55% and made corresponding adjustments to the books for Longspar and the trust. Longspar also adjusted prior distributions and made a subsequent proportional cash distribution to its partners to reflect the newly adjusted interests.

In the August 29, 2013, notices of deficiency, the IRS determined that the Nelsons had undervalued the December 31, 2008 gift, and their halves of the gift each were worth $1,761,009 rather than $1,048,000 as of the valuation date. The IRS also determined that the Nelsons had undervalued the January 2, 2009, transfer by $13,607,038, and therefore they each had made a split gift in 2009 of $6,803,519. The Nelsons filed separate petitions in the Tax Court, which were consolidated for trial.

After its typical avoidance of IRC Sec. 7491 regarding the burden of proof shift, Judge Pugh determined that the Nelsons had given and sold percentage interests rather than having made defined value transfers. He reasoned:

Unlike the clause in Succession of McCord, “fair market value” here already is expressly qualified. By urging us to interpret the operative terms in the transfer instruments as transferring dollar values of the limited partner interests on the bases of fair

market value as later determined for Federal gift and estate tax purposes, petitioners ask us, in effect, to ignore “qualified appraiser * * * [here, their appraiser] within * * * [a fixed period]” and replace it with “for federal gift and estate tax purposes.” While they may have intended this, they did not

write this. They are bound by what they wrote at the time. As the texts of the clauses required the determination of an appraiser within a fixed period to ascertain the interests being transferred, we conclude that Mrs. Nelson transferred 6.14%

and 58.35% of limited partner interests in Longspar to the Trust as was determined by their appraiser within a fixed period.

[Emphasis added]

Judge Pugh went on to determine the value of the percentage interests transferred. He essentially split the difference, determining that Mrs. Nelson’s transfers to the trust have fair market values of $2,524,983 (about a $430,000 difference) and $24,118,933 (and $4,118,933 difference), respectively, and the same applied to Mr. Nelson’s transfers. The case is appealable to the Fifth Circuit.

COMMENT:

Sadly, this is the correct result. The value was to be determined by their appraiser, not as finally determined for federal estate and gift tax purposes. The moral of this story: those ten missing words (as finally determined for federal estate and gift tax purposes) must be in every defined value transaction document!!! It’s unclear whether the Nelsons engaged separate counsel for the trust, which always is advisable.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE

DIFFERENCE!

Paul Hood

CITE AS:

LISI Estate Planning Newsletter #2801 (June 25, 2020)

at http://www.leimbergservices.com  Copyright 2020 Leimberg Information

Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITES:

Nelson v. Commissioner, T.C. Memo 2020-81; McCord v. Commissioner,

461 F.3d 614 (5th Cir. 2006); Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944); Knight v. Commissioner, 115 T.C. 506 (2000); King v. United States, 545 F.2d 700 (10th Cir. 1976); Estate of Christiansen v. Commissioner, 586 F.3d 1061 (8th Cir. 2009); Estate of Petter v.