The case you’re about to read focuses on the amount of the estate tax charitable deduction. The matter of how the charity should have been paid additional millions of dollars wasn’t before the court. In the case, the U.S. Court of Appeals for the 9th Circuit affirmed the Tax Court’s decision limiting the estate tax charitable deduction to the amount actually received by the charity, the Bob and Evelyn Dieringer Family Foundation (Foundation) and not the value of the contributed assets at the decedent’s death. The estate claimed an $18,205,476 charitable deduction based on the value of the assets bequeathed to the Foundation at the decedent’s death. But the Foundation received assets worth only $6,434,578. The overvaluation of the charitable deduction would have avoided $4.1 million in estate taxes. Thus, the court affirmed the deficiency against the estate for overstating the charitable deduction and the penalties imposed by the Tax Court. The key to the court’s decision was its finding that the family manipulated the assets for personal gain. Apparently, the court tried to do justice by limiting the estate tax charitable deduction. But that didn’t increase the amount the Foundation should have received.
How It All Started
Victoria Dieringer and her late husband had 12 children, including Eugene, Patrick and Timothy. The family owned Dieringer Properties, Inc. (DPI), a closely held corporation that manages commercial and residential properties in Portland, Ore. and a Wendy’s restaurant in Texas. Before Victoria's death, Eugene was the president of DPI, Patrick was the executive vice president and secretary, Victoria was the vice president, and Timothy was the office manager. DPI’s board consisted of Victoria as chairperson and Eugene, Patrick, Timothy and Thomas Keepes (who’s unrelated to the Dieringers) as directors. None of the other nine Dieringer children were involved in DPI.
Before Victoria's death, the only shareholders of DPI were Victoria, Eugene and Patrick. Victoria owned 425 out of 525 voting shares and 7,736.5 out of 9,220.5 nonvoting shares. Eugene owned the remaining 100 voting shares, and Eugene and Patrick each owned 742 nonvoting shares.
Under Victoria’s 2000 will, on her death, all her estate would pass to the Victoria Evelyn Dieringer Trust (the trust). The trust provided for Victoria’s children to receive some personal effects but nothing else. The trust also provided for $600,000 in donations to various charitable organizations. Assets remaining in the estate would then pass to the Foundation (an Internal Revenue Code Section 501(c)(3) organization) as a charitable contribution. Eugene was appointed as the sole trustee of both the trust and the Foundation. Patrick and Keepes served as advisory trustees of the Foundation.
Before Victoria’s death, the DPI board had preliminary discussions about purchasing Victoria’s DPI shares as part of ongoing succession planning. A Nov. 24, 2008, board resolution reported that the issue had been discussed and that the board resolved to “periodically purchase” Victoria’s shares based on terms acceptable to all parties. Victoria was “completely agreeable” to that plan. At a Feb. 13, 2009, board meeting, Victoria reiterated her potential interest in having DPI purchase her shares. In anticipation of entering a purchase agreement for Victoria’s shares, DPI paid the trust $45,000 before Victoria’s death. When Victoria unexpectedly died in April 2009, no specific redemption agreements were in place.
Value of Shares
Eugene was appointed executor of Victoria’s estate. To determine the value of Victoria’s DPI shares for estate administration purposes, the estate’s law firm requested that Lewis Olds & Associates perform an independent appraisal of DPI’s net asset value. The appraisal determined that the value of DPI as of the date of Victoria’s death was $17,777,626 and that Victoria’s shares in DPI were worth $14,182,471.
Conversion to S Corp
Effective Nov. 20, 2009, DPI’s board converted the corporate structure from a C corporation to an S corporation (S corp). The DPI board made this change in corporate structure to accomplish its long-term tax planning goals and to avoid certain adverse tax consequences under IRC Section 1374. As a result of electing S corp status, the DPI board decided that it should also redeem Victoria’s DPI shares that were to pass to the Foundation.
Redeeming the Shares
The board entered into an agreement with the trust to redeem Victoria’s shares prior to the shares pouring over into the Foundation. Initially, DPI agreed to redeem all of Victoria’s shares for $6,071,558, effective Nov. 30, 2009. That amount was based on a 2002 appraisal, because the date-of-death appraisal hadn’t yet been completed. As a result, the redemption agreement provided that the stated price would be “reconciled and adjusted retroactively” to reflect the fair market value (FMV) of the shares as of Nov. 30, 2009. DPI executed two promissory notes payable to the trust in exchange for the DPI shares. Eugene, Patrick and Timothy entered into separate subscription agreements to purchase additional DPI shares to provide funding for DPI to meet the required payments on the promissory notes.
At the direction of DPI, Lewis Olds & Associates performed another appraisal of the value of Victoria’s DPI shares as of Nov. 30, 2009, for the purpose of redemption. The redemption appraisal valued Victoria’s DPI shares at $916 per voting share and $870 per nonvoting share. Lewis Olds testified, and the Tax Court found, that Eugene (through his lawyer) instructed him to value Victoria’s DPI shares as if they were a minority interest in DPI for the purposes of this appraisal and that he wouldn’t have done so without these instructions. Olds’ appraisal therefore included a 15% discount for lack of control and a 35% discount for lack of marketability. As a result, Victoria's DPI shares were valued significantly lower in the redemption appraisal than in the date-of-death appraisal.
DPI determined that it couldn’t afford to redeem all of Victoria’s shares. The redemption agreement was then amended, and consequently, DPI redeemed all 425 voting shares and 5,600 nonvoting shares for a total purchase price of $5,263,462.
In January 2011, the trust distributed the promissory notes and the remaining DPI shares to the Foundation. The state probate court approved the redemption agreement and indicated that the redemption agreement and promissory notes wouldn’t prohibit acts of self-dealing under IRC Section 4941. (The 9th Circuit didn’t comment on the probate court’s conclusion.)
In June 2013, the IRS issued a deficiency notice to the estate based on its July 2010 tax return (Form 706). The notice stated that there was a deficiency of $4,124,717 and imposed an accuracy-related penalty of $824,943 under IRC Section 6662 for error and negligence in using the date-of-death appraisal as the value of the charitable contribution of Victoria’s DPI shares.
Tax Court Decision
The estate appealed to the Tax Court, arguing that it correctly used the date-of-death appraisal to determine the value of Victoria’s DPI shares for the purpose of the charitable deduction. The IRS responded that post-death events should be considered in determining the value of the charitable contribution because the actions by Eugene, Patrick and Timothy reduced the value of Victoria’s contribution to the Foundation.
The Tax Court upheld the IRS’ reduction of the estate’s charitable deduction and the deficiency assessment. The Tax Court found that the redemption wasn’t part of Victoria’s estate plan. The Tax Court concluded that post-death events—primarily Eugene’s decision to apply a minority interest discount to the redemption value of Victoria’s DPI shares—reduced the value of the contribution to the Foundation and therefore reduced the value of the estate’s charitable deduction. The evidence, said the Tax Court, didn’t support the conclusion that a poor business climate caused the reported decline in share values, as the estate argued.
Grounds for 9th Circuit Appeal
The estate challenged the Tax Court’s decision on these grounds:
- The Tax Court erred by taking into account events that occurred after Victoria’s death in determining the value of the charitable deduction.
- The charitable deduction should have been valued as of Victoria’s date of death.
- Even if post-death events could be considered, the Tax Court erred by not accounting for a decline in value of Victoria’s shares caused by economic forces.
- The Tax Court erred by upholding the accuracy-related penalty under IRC Section 6662.
The crux of the matter: Whether the estate’s charitable deduction should be valued at the time of Victoria’s death or whether the post-death events that decreased the value of the property delivered to charity should govern.
The 9th Circuit said that because the estate tax is a tax on the decedent’s bequest of property, the valuation of the gross estate is typically done as of the date of death. Except in some limited circumstances, such as when the executor elects to use an alternative valuation under IRC Section 2032, post-death events generally aren’t considered in determining the estate’s gross value for purposes of the estate tax. The parties agreed that the executor didn’t use the alternative valuation method.
It also noted that IRC Section 2055(a) allows for deductions from the value of the gross estate for transfers of assets to qualified charitable entities. This deduction generally is allowed “for the value of property included in the decedent’s gross estate and transferred by the decedent ... by will.” It emphasized that the purpose of allowing charitable deductions is to encourage testators to make charitable bequests, not to permit executors and beneficiaries to rewrite a will so as to achieve tax savings.
In valuing the charitable deduction, the court noted that deductions are valued separately from the valuation of the gross estate. Separate valuations allow for the consideration of post-death events. The court referred to its ruling in Ahmanson, in which it addressed the valuation of a charitable deduction. There, the decedent’s estate plan provided for the voting shares in a corporation to be left to family members and the nonvoting shares to be left to a charitable foundation. The court held that when valuing the charitable deduction for the nonvoting shares, a discount should be applied to account for the fact that the shares donated to charity had been stripped of their voting power. That a discount wasn’t applied to the value of the nonvoting shares in the gross estate didn’t impact the court’s holding. The court recognized that a charitable deduction “is subject to the principle that the testator may only be allowed a deduction for estate tax purposes for what is actually received by the charity.”
The 9th Circuit disagreed with the estate’s argument that the estate tax deduction should be the value of the assets on the date of Victoria’s death in keeping with the date-of-death valuation rules because although the U.S. Supreme Court and the 9th Circuit have applied that valuation method when the remainder of an estate is donated to charity after a post-death contingency, there’s no uniform rule for all circumstances. It noted that, “[t]he proper administration of the charitable deduction cannot ignore such differences in the value actually received by the charity.” Under Ahmanson, this rule prohibits crafting an estate plan or will so as to game the system and guarantee a charitable deduction that’s larger than the amount actually given to charity.
The court applied the rule in Ahmanson to the facts of this case. Victoria structured her estate so as not to donate her DPI shares directly to a charity or even directly to the Foundation but to the trust. Victoria enabled Eugene to commit almost unchecked abuse of the estate by setting him up to be its executor, as well as trustee of the trust and trustee of the Foundation, in addition to his roles as president, director and majority shareholder of DPI. As the Tax Court found, Eugene improperly directed Lewis Olds to determine the redemption value of the DPI shares by applying a minority interest valuation, when he knew a majority interest applied, and the estate had claimed a charitable deduction based on a majority interest valuation. Through his actions, Eugene manipulated the charitable deduction so that the Foundation received only a fraction of the charitable deduction claimed by the estate.
The Foundation (properly not a party to this estate tax case) should receive an amount equal to the value of the assets at the decedent’s death. But, alas, the Foundation is controlled by the decedent’s family. And the family benefited by what I deem to be a step transaction.
Questions: Has the executor/trustee breached his fiduciary duty? Should the Oregon attorney general look into this? Has the statute of limitations run out?
The solution: The IRS should impose self-dealing taxes under Internal Revenue Code Section 4941 on the S corp and the decedent’s children who ended up getting the stock at a bargain-basement price. Again, has the statute of limitations run out? The S corp and family members should pay the Foundation an amount equal to the stock’s FMV at the decedent’s death minus the amount the charity received on the stock’s redemption. Interest on the shortfall should also be paid to the Foundation.
© Conrad Teitell 2019. This is not intended as legal, tax, financial or other advice. So check with your advisor on how the rules apply to you.