Estate of Valeria M. Miller, Deceased, Virgil G. Miller, Executor, Petitioners

T .C . Memo . 200'9- 19 _ UNITED STATES TAX OUR T ESTATE OF VALERIA M . MILLER, .DECEA$ED, VIRGIL G . MILLER , EXECUTOR,'-Petitioner v . COMMISSIONER OF INTERNAL REV:NUE, Respondent Docket No . 5207-07 .

MEMORANDUM FINDINGS OF FACT AND OPINION

GOEKE, Judge : Respondent determined a deficiency o f $1,019,399 in the Federal estate tax of the Estate of Valeria M .

'On brief the parties agree that tfie estate is entitled t o deduct $12 for unpaid income taxes . - (continued .

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SERVE ;

MAY 272

we must decide whether the value of the gross estate includes an !amount for which the estate of Valeria M . Miller's (decedent's ) .predeceased husband (Mr . Miller) claimed a marital deduction . We find that those amounts for which Mr . Miller's estate claimed a marital deduction are properly included in the value of decedent's gross estate . Second, we must determine whether the estate is required to include in the gross estate the total value of assets transferred to decedent's family limited partnership i n April 2002 and May 2003, or if those transfers qualify for a discount . We find the value of those securities transferred t o decedent's family limited partnershipi,in April 2002 qualifies for a discount, while the value of those assets transferred in May [2003 does not qualify for a discount .

Unless otherwise indicated, all section references are t o 4theInternal Revenue Code in effect for the date of decedent' s II li .,death and all Rule references are to the Tax Court Rules o f ,jPractice and Procedure . ~s .

. .continued ) Further, the estate raised on brief the issue of a".deduction for legal fees incurred after decedent's estate's estate tax return was filed . Respondent in reply conceded that the estate will be allowed a deduction for legal,ffees incurred at or after trial,to the extent the estate is able to substantiate those fees . These issues will be addressed in the parties' Rule 155 computation .

r, ,FINDINGS OF FAC T 1 .

Introductio n Some of the facts have been stipulated and are so found : , The stipulation of facts and the accompanying exhibits-are .

incorporated herein by this reference . On the date . of her death, May 28, 2003, decedent was a resident o Indiana . Virgil G .

Miller (Virgil G .) was appointed execut r ;of decedent's estate .

At the time the petition was filed on b :half of the estate ; Virgil G . was a resident of Indiana :

2 .

Mr . Mille r Decedent married Mr . Miller on February 12 ., 1938, and they remained married until Mr . Miller's death on February 2, 2000 .+ Decedent and Mr . Miller had four children : Virgil G ., born August 1939 ; Gordon, born July 1942 ; Do ald, born July 1944 ; and Marcia, born December 1946 . Virgil G . ,s a retired architect :J Donald is a retired manager of .recreation activities at Fort Benjamin Harrison . Marcia was married ut separated from her, husband in September 2002 . They were divorced in January 2003 ; and she died in February 2006 .

Mr . Miller was an architect until .,-his retirement at age⁶⁰ .

Decedent served as Mr .,Miller' .s secretary and helped start hsi architecture business . From retirement . .to his . death, at age86in 2000, Mr . Miller devoted his time to researching and'investingjin securities . Mr . Miller spent significa t,time managing his 4 - family's investments and employed a specific investment methodology--charting stocks . Charting stocks involved .the purchase and sale of securities on the basis of an analysis o f their daily high and low values . Mr . Miller kept handwritte n records of his investment activity .

On October 29, 1991, Mr . Miller established the Virgil J .

Miller Living Trust (the revocable trust) . The agreement establishing the trust also established a life estate marita l trust for decedent (the QTIP trust) . .

Mr . Miller predeceased decedent . Virgil G . as executor of 11the estate timely filed a Form 706,,United States Estate (an d Gener.ation-Skipping Transfer) Tax Return, with the Interna l Revenue Service (IRS) .

On the date of Mr . Miller's death, his gross estate was ,,valued at $7,667,939 . Of his gross estate, $7,635,755, or 99 .6 ;percent, consisted of securities held by his revocable trust .

Virgil G . made an election pursuant to section 2056(b)(7) to treat1the QTIP trust property as qualified terminable interes t !property . Mr . Miller's estate claimed a marital deduction of $11.,060,000 for assets funding the QTIP trust . The QTIP trust was made~!up of'five accounts with Merrill"Lynch . On October 6, 2000, securities were transferred from the1iVirgil J . Miller Living ij Trust .Merrill Lynch account to Merrill Lynch-account No . 634- "37.225 (account 7225), in the name of ?`the QTIP trust . The 5 - securities had a fair market value of $1,113,372 on October 27 ; .

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2000 . A portion of the securities used to fund account 7225 was then used to fund four additional Merrill Lynch accounts, numbered 8135 (account 8135), 8136 (acc unt 8136), 8137 (account 8137), and 8138 (account 8138) . The transfers from account 7225 to the additional four accounts werema e in June 2001 . Each' transfer had,a fair market value of aboit $100,000 .

Virgil G . was trustee of the QTIP rust, and the trus t agreement provided that all income of t e QTIP trust was totbe j distributed to decedent at least annua l y and that income was no t .to accumulate in the QTIP trust . Deced nt did not receive an y distributions or income from the QTIP trust . All income from th e QTIP trust was reported on its own For m 1041, U .S . Income Tax i Return for Estates and Trusts .

On October 9, 2000, the remaining assets in the revocable!

trust, then valued at approximately $3 . million, were distributed to decedent's Revocable Liv ;ng Trust (decedent' s trust) . Decedent's trust held an accou it with Merrill Lynch :

(decedent's trust's Merrill Lynch account) and an additional account at Fidelity Investments (decedent's trust's Fidelity' Investments account) .

3 .

Decedent's Social Life and Gift Giv nci Decedent was involved in numerous ommunity, social, and religious activities including volunteering at nursing homes, joining a singing,group, .reading at church, and playing cards .

Decedent was never deemed incapacitated or incompetent and wa s never,; under a guardianship .

,,!Decedent made annual gifts to her'children, her children' s spouses, and her-grandchildren , beginning by at least 1994 an d continuing every year , thereafter until her death .

Decedent an d Mr . Miller established trusts for the benefit of decedent' s grandchildren . Virgil G : was truste'e'of each irrevocable trust .

Decedent made annual gifts to the irrevocable trusts .

On May 1, 1994, decedent established the Valeria M . Miller , jIrrevo`cable Trust, of'which Virgil G .'!was trustee Decedent made annual gifts to the Valeria M . Miller Irrevocable Trust whic h ,,were-Used by Virgil G . as trustee to pay life insurance : premiums foEr ;life insurance policies on decedent . The trust owned two 'life .'„ansurance policies which were sold on August 3, 2002, for a total of $962,500 . The proceeds were kept in the trust' . The !lipfe insurance' policies eventually ::paid benefits of $2,750 ;000 t o the purchaser upon decedent's death .

'On June 22, 1999, decedent signed a gift annuity agreement with the National-Heritage Foundation, a charitable' organization .

which paid her $4,390 per month for the rest of her life . At 'decedent's death the remainder was distributed to the National Heritage Foundation .

4 .

The Miller Family Limited Partnershi p Mr . Miller and decedent received e state planning advice . from David Price (Mr . Price) of Price & Coll ins, L .L .P . (Price & Collins) . After Mr . Miller died, deced nt sought further estate planning advice from Mr .-Price . On the .basis of Mr . Price' s advice, decedent decided to form a fami ly limited partnership .

On November 21, 2001, the Indiana secre ary of state issued a certificate of limited partnership of the V/V Miller Family Limited Partnership (MFLP) . Decedent was 86 when MFLP was formed . The MFLP agreement was prepare by Mr .-Price and was signed by Virgil G . as general partner, by decedent as trustee'of her trust, and by Donald, Marcia, and G rdon as limited partners .

Virgil G .'s address was used as MFLP's business address .

On December 13, 2001, MFLP applied for an Employer Identification Number, which it later r ceived from the IRS .

Although MFLP held no assets as of-Dece ber 31, 2001, the fair, market value per unit of a limited partnership interest in MFLP was appraised as of that date for gift tax purposes (the December 31, 2001, valuation) . Because MFLP had .not .yet been funded, Virgil G . provided statements to . the appraiser detailing th e assets that were going to be used to fund MFLP .

The December 31, 2001, valuation indicates that MFLP had marketable equity securities as of that date of $4,336,380, a margin account . payable of $499,573, and a net asset value of .!

_ 8 _ !$3,836,807 . The December 31, 2001, valuation applied a~35 Iperce'nt lack of marketability discountfto the purport e'd,~net asse t ,!value of MFLP and concluded that as of that date MFLP had a fai r market, value per unit of $2,264 .73 .

The MFLP agreement had not been 'signed as of February 8, 2002 .,! On February 8, 2002, Mr .. Price sent Virgil G . a letter along with a partnership agreement and signature pages fo r ,decedent and her children .- On February 26, 2002, Virgil G .

iii mailed the partners' individual signed signature pages back t o Mr . Price . On March 6, 2002 . ; a paralegal at Price & Collins sen t Virgil G . the MFLP agreement along-with certificates o f partrership interest for him .to sign . Virgil G . signed ; the.

,certificates and dated them November .27, 2001 .

On March 28, 2002, .a paralegal at Price & Collins sent Virgil G . revised MFLP certificates and a revised MFLP agreement .

Eachwof the intended partners of MFLP signed the-partnership ;agreement and was issued a certificate representing hisor her !I interests in the partnership . The MFLP issued 1,000 units ; .de-cedent'srtrust: :owned 920 units and "continued to own that number on the'date of her death . . Decedent',s children received their ,partnership units as giftssfrom decedent . Virgil G . received 10 ,,general partner units and 10 limited partner units . Donald , ;Gordon, and Marcia each received 20 limited partner units .

jDe`cedent's children continued to own"ithose units on the : . date of decedent's death . .The MFLP agreement provided for centralized asset management by vesting management and control exclusively i n the general partner, Virgil G .

The MFLP agreement provided :

The purpose of * * * [MFLP] shall e to buy, sell, and trade in securities of any nature, including short sales, on margin, and .for such purposes may aintain and operate margin account with brokers, and tb pledge any securities held or purchased by them with sucL brokers as security for loans and advances made to the Trustees . ; buy, sell and trade in commodities, commodity : futures ontracts and options on commodity futures contracts ; and bay, sell, trade or deal in precious metals of any kind . Additionally, to maintain a margin account with a stock brokerage firm, to execute al l documents necessary for the openin to borrow money from .a brokerage f owned by the Trust as collateral a interest therein, and to permit th stock brokerage firm to relend,these securities in .the ordinary course of its business . Additionally * * * [MFLIP] may acquire such assn s r es and any and all other and engage in investments of all t lawful purposes-,that may be conduc partnership as deemed appropriate and maintenance thereof, irm, to pledge securities ad to grant a securit ed by'a limite d y the General Partner .

y The MFLP agreement also included a right of first refusall should a limited partner wish to dispos of his or her interest , in MFLP and a clause requiring the part hers to submit any dispute among themselves to arbitration . Furth r, Virgil G ., as genera l partner, was required to act in further tnce of MFLP's interest s and had fiduciary obligations to the partnership and the limite d partners .

MFLP established accounts at Fidelity Investments an d Merrill Lynch . MFLP held one account at Fidelity (MFLP Fideli -y account) and three accounts at Merrill Lynch, account Nos . 7Bl⁰, 7B¹²,-and 7B¹³ . Decedent made her first contribution to MFLP in Aprl ;'2002 .

a .

Merrill Lynch Account Transfer s On March 28, 2002, MFLP's Merrill Lynch account No! 7B¹⁰ had a zero balance . On April 10, 2002, decedent's trust contributed "equity securities from decedent's trust's Merrill Lynch accoun t oIMFLP's Merrill .Lynch account No . 7B¹⁰ . The securities had a value,of $2,766,004 After this transfer was complete, fund s were .transferred from account No . 7B¹ :0 to account Nos . 7B¹² and 7Bl³ .,' On April 18 and 22, 2002, MFLP transferred securities fro m MFLP's Merrill Lynch account No . .7B10'1to MFLP's Merrill Lync h account No . 7B¹² . The transferred securities had a value on ,iApril. .,30, 2002, of $92,246 . On April 18 and 22, 2002, MFLP, !transferred securities from MFLP's Merrill Lynch account No . 7B¹ 0 to,MFLP's Merrill Lynch account No . 7B¹³ . The securities had a value~,on April 30, 2002, of $95,957 .'~~ ,b .

Fidelity Investments Account Transfer s ..On March 31, 2002, decedent's trust's'Fidelity Investments account had a net value of $2,152,625 . On that same date MFLP's Fidelity Investments Account had a zero balance .

On April 10 , 2002, decedent transf rred $ 1,197,668 of securities from decedent 's trust's Fide ity Investments accoun t to MFLP s Fidelity Investments account .]

' I The April 2002 transfers constituted about 77 percent o f decedent's net assets .

c .

Margin Account s Decedent's trust's Merrill Lynch a d Fidelity Investments , accounts often made purchases on margin When an investo r purchases a security on margin , he or she buys the security on .

credit . A margin balance is the'total alance in a margi n account . If the balance is negative , then the amount shown is :

owed to a brokerage firm . If the balance is positive , then that balance is available to earn interest .

Decedent ' s trust's Merrill Lynch and Fidelity Investment s accounts both had negative margin balan es after the transfers of securities described above, even though the securities purchased on margin were no longer in the trust's accounts . In order to pay off the margin accounts, MFLP sold ome of the securitie s 2The estate argues that respondent incorrectly valued th'is' transfer because respondent used a monthly statement ending Apr . 30, 2002, as the source for pricing inf(rmation . However, the, Fidelity Investments account statements show, in addition to beginning and ending account values, va ues per transaction . Respondent's valuation of the securitie transferred mirrors the Fidelity account statement's valuations of the securities transfer .

purchased on margin and transferred :.to .MFLP and transferred . the prbceeds back to decedent's trust's accounts .

On March 28, 2002, decedent's Trust's Merrill Lynch account ,had a,;,debit balance of $276,926 . On April 10, 2002, MFLP's Merrill Lynch account No . 7B¹⁰ transferred $277,400 to decedent' s .l trust's'Merrill Lynch account . Another transfer of $39 :'42 was made„on April 10, 2002 .

On April 17, 2002, MFLP sold, through MFLP's Merrill Lync h account No . 7B¹⁰, 13,600 shares of AOL Time Warner, Inc . and 68 0 shares of'Cisco Systems, Inc . stock^fior $272,685 and $10,576, respectively (totaling $283,261) .

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.On April 30, 2002, decedent's trust's Merrill Lynch account had ;a'debit balance of $1,896, and .MFLP's Merrill Lynch account No .°,,7B¹⁰ had a debit balance of $320 .

II On April 19, 2002, MFLP sold $147,249 in securities fro m MFLP.,'s Fidelity Investments account .JA On April 15, 2002, MFLP transferred $51,801 in cash from MFLP,'s Fidelity Investments account to decedent's trust's Fidelity Investments account .

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S MFLP Managemen t Virgil G . owned VGM Enterprises . MFLP paid VGM Enterprises monthly fee to manage the partnership's securities . Virgil G .

wasthe only employee of VGM Enterprises and worked about 4 0 hours per week managing .MFLP's assets . Mr . Miller hadFtaugh t Virgi'1 G . how to chart stocks, and Virgil G . managed MFLP's assets . according to .this .philosophy Virgil G . began-managing the securities, shortly after decedent's first transfers to MFL P in April 2002 . Virgil G . subscribed to trade publications an d purchased, computer software to assist h'm in researching securities and carrying out MFLP's securities trading .- 6 .

Contributions to,MFLP in 2003 (cid:127) Decedent made additional contributions to MFLP in 2003 .

Although decedent had been suffering from certain chronic conditions associated with old age, her day-,to-day health was ., strong .

On April 25, 2003, decedent suffered a fall at her residence and broke her hip . . The next day, while she was awaiting surgery, doctors discovered that decedent was having sinus pauses, which indicated that her heart was stopping 1 nger than normal .

Decedent underwent pacemaker implantati n surgery on April-28, 2003, and orthopedic surgery to repair her broken hip on April` 4 30, 2003 . The,pacemaker implantation s before the orthopedic surgery to .ensure that decedent' s . heart°was beating regularly and strongly when th e hip surgery wa s performed, in order to increase decede n surviving and recovering .

On May 8, 2003, decedent was disch rged from the hospital and transferred to a'continuing care fa ility for rehabilitation .

Decedent was to undergo rehabilitation d physical therapy soI ; 14 - ,Ishe would be-able to return home . On May 12, 2003, decedent was brbught back to the hospital from they,continuing care facility 11because7she was retaining fluid and was short of breathe Upo n returning to the hospital decedent was diagnosed with congestiv e heart failure .

Hospital policy at that time was for all patients regardles s 'of'ageto fill out code status forms and orders upon admission to I the hospital . These documents would inform the doctors caring for a. .,,patient of the patient's wishes,, and the type of action t o .be taken in the event of a medical episode . On May 12, 2003 , 'jdecedent' s code status was Level I, Full Code, which indicate d that" if decedent was to experience . any sort of acute medica l episode, all measures possible would be undertaken to return . .

,:decedent to consciousness and health .a' = On May .19, 2003, a bruise was discovered on decedent's scalp while:her daughter and daughter-in-law were fixing her hair .

A CT, scan performed that same day revealed .a moderately enlarge d subacute subdural . hematoma , a type of traumatic brain injury .

On May 20, 2003, decedent's doctor discussed with her and her family surgical options versus comfort care only . . On tha t ',same day decedent's code order was changed to Level IV, No Code, Comfort Measures Only . Decedent died on May 28, 2003 . Her death certificate stated the cause of death as "Coroner-Respiratory.

Arrest ; Subdural Hematoma ; Fall" . 3 a .

Fidelity Investments Account s After decedent broke her .hip but b fore her bruise wa s discovered, she signed a letter dated M y 9, 2003, addressed t b Fidelity Investments requesting that Fi elity Investments , transfer all of her assets, except for ash in her Fidelit y Investments mone y market account, over nd into MFLP's Fidelity, Investments account . Virgil G . wrote,tie : .letter and cosigned .,a s trustee of decedent's trust . On May 17 2003, Virgil G . wrote a check from decedent's trust's Fidelity .nvestments account it the amount . of $105,000 as an additional . cap'tal contribution to,'MFLP .

There appear to have been a numbe r of transfers betwee n decedent's trust's Fidelity . Investments account and MFLP' s Fidelity Investments account in May 200 However, the amounts and dates of these transfers are record d differently on the .May and June 2003 account statements issued to MFLP .

The May 2003 statement-shows a transfer of securities wort h approximately $79,690 from decedent's ti-ust's Fidelit y Investments account to MFLP's Fidelity . nvestments account on :May 15, 2003 . This transfer was made up o f decedent's : holdings i n three corporations .

3The death certificates listed the backwards--i .e ., a fall caused a,subdur respiratory arrest .

causes of deat h it hematoma, which caused 16 - The May 2003 statement also shows a transfer of securities worth approximately $930,751 from decedent 's trust's . Fidelity Investments account to MFLP's Fidelity Investments account on May 20 ., 2003 . This transfer was substantially all of decedent' s holdings in her,trust's Fidelity Investments account and appeared Itoinclude .the securities that had already been transferred to MFLP on May 15, 2003 .

, :Lastly, the May 2003 Fidelity Investments account statement shows .!a transfer of securities worth approximately $95 .0,286 fro m ,MFLP'o,s Fidelity Investments account back to decedent's trust's Fidelity Investments account .

Thus, according to the May 2003 MFLP Fidelity Investment s account statement, the net amount of distributions fro m decedent's trust's Fidelity Investments account to MFLPs ,;Fidelity Investments account was $60,,155 . Decedent's trust ' Fidelity Investments account would have had a balance of $ 889,89 8 on May 31, 2003 .

The June 2003 statement for decedent's trust's .Fidelity Investments account, however,'shows only-one transfer : a transfer of assets worth approximately $878,069 from decedent's trust's Fidelity Investments account to MFLP's Fidelit y li Investments account on May 15, 2003 . The May and June 2003 statements do not explain why the transfers are recorded differently on the respective statements . According to the June 2003 statement, decedent ' s trust's Fide lity Investments account had a balance of $49,180 on June 30, 20 03 . Virgil G . explained that the discrepancy resulted from erro rs made by Fidelity and j that he never authorized the transfer o f any . securities from :MFL P back to decedent ' s trust .

b .

Merrill Lynch Accounts On April 30, 2003, decedent's trus 's Merrill Lynch accoun t had a balance of $184,819 . On May 19, 003, decedent's trus t Merrill Lynch account transferred all o, its marketabl e securities and $14,650 to MFLP's Merrill Lynch account No . 7B¹⁰ .

On May 30, 2003, decedent's trust's Mer ill Lynch account had a balance of $7 .

The MFLP is still i n existence , an Virgil G . continues,to serve . as general partner . MFLP made no distributions to Virgi l G ., Gordon, Donald, or Marcia in 2002 a :d_2003 .

Decedent's will devises the remain er of her estate, after payment of administration expenses, to ecedent's living trust .', Decedent's living trust agreement provides that upon decedent's death the assets . in her trust are divid~d into a portion A trust and a portion B trust . The portion A bust was to be a generation-skipping transfer tax exempt trust . The portion B , trust would be funded with the remainder of decedent's estat e after the portion'A trust was funded . he portion B trust was I 18 - divided into four subtrusts for the benefit of each of decedent's f our--" .children .

' 111 7 . ' MFLP Trading Activit y discussed above, M r . Miller spent his retirement chartin g ,stocks and managing the family's investments . Decedent wante d the family assets to be managed in accordance with Mr . Miller' s ;investment=strategy-after her death . 'MFLP actively managed the pcashf ;;and securities decedent transferred in April 2002"and Marc h 2003 . Before making contributions to MFLP decedent's trust's accounts made very few trades, but trading activity increase d after the securities were transferred to MFLP . The overall valu e the transactions varied month to,month . However, MFLP' s Merrill-Lynch account Nos . 7B¹² and 7B¹³ showed sales and purchases of about $3 ,000 to $4,000 per month during 2002 an d 2003 . Virgil G ., as general partner, also kept his sibling s informed about MFLP's status and provided financial advice t o them 1I 19 - A Form 706 was filed on behalf of the Estate of Valeria M .

Miller on February 22 ., 2004 . The Form 706 showed a gross estat e of $2, .637,024, and tax due of $994,299 . The gross estate included 920 MFLP units valued at $2,589,118 .

The Form 706''did not include the values of the securities used to fund the QTIP trust in the value of the gross estate . Decedent's Form 706' indicated that decedent was the beneficiary of .a trust for which a deduction was claimed by the estate of_a predeceased spous e under section 2056(b)(7) and which was not reported on decedent's Form 706 .

On November 30, 2006, respondent issued a notice o f deficiency (the notice) that, in part,'increased the value of decedent's gross estate by $546, .702,(cid:127) the purported fair market value of the securities in the QTIP trust, and by the amount of decedent's transfers to MFLP ._-A timely petition for redetermination was filed with the Cour on March 5, 2007 .

OPINION

A Federal estate tax is . imposed " o the transfer of the ` taxable estate of : every decedent who is a citizen .or resident of the United States ." Sec . 2001(a) . The estate tax is imposed o n the value of the taxable estate with specified adjustments made .

Sec . 2001(b) . The value of a decedent's taxable estate is the ; value of the gross estate less enumerated deductions . Sec . 2051 .

The value of the gross estate includes he values of all of decedent's-property to the extent provided under sections 2033 through 2045 . Sec . 2033 .

I . Burden : of Proo f Generally the taxpayer bears the~-burden of proving the Comm'issioner's,determinations are erroneous . Rule 142(a) .

However, with respect to a factual issue,relevant to th e liability of a taxpayer for tax, the burden may shift to th e Commissioner if the taxpayer ., has produced credible evidenc e Irelating to the issue, met substantiation requirements, maintained records, and cooperated with the Secretary' :

lfreasonable requests for documents, witnesses,,and meetings . Sec .

7491(.a) . Neither party- addressed themburden of proof . Our resolution of the issues is based on,the preponderance of the evidence rather than the,allocation-of the burden of proof .

II .

Mr . Miller's Estate's .Marital Deductio n We first'determine whether decedent is required to include in her estate the securities used to fund the QTIP trust . As discussed above, Mr . Miller's estate claimed a marital deduction in ;; .the amount .of the fair market value of those securities .

11,PSection 2056(a) grants a deduction for the value,of any interest in property passing to a surviving spouse . which . is ;[included in determining-the value of, .the gross estate . ',Pursuant topj section 2056(b) (1) -, a marital deduction cannot ordinarily be claimed for property passing to a surviving spouse where the interest of a surviving spouse may'eve ~ tually terminate or fail .

However, section 2056(b)(7) allows a'ma rital deduction fo r qualified terminable interest propert y (QTIP) .

QTIP is define d in section 2056(b) (7) (B) (i) as propert y which passes from a .

decedent, in which the surviving spouse has a qualified income ; interest for life, and to which=an ele c tion-applies .

I Section 2056(b)(7)(B)-(ii) provides that the surviving . spous e has a qualifying income interest for li fe .if the surviving spotis e is entitled to all the income from the property, payable-annuall y or at more frequent intervals, and .no p erson has a power t o appoint any part of the property to any person other than the,f surviving spouse . Under section 2056( b )(7)(A), QTIP is treate d for purposes of section 2056(a) as pass ing to the survivin g spouse and for purposes of section 2056 (b) (1) (A) as not passing to any person other than the surviving spouse . Pursuant to section 2056(b)(7)(B)(v), a QTIP electi On with respect to any;, property shall be made by the executor n the Federal estate-tax return and once made is irrevocable .

Section 2044 sets forth the tax treatment of QTIP in the .

.estate-of the surviving spouse . Under ection 2044(a), the value of the gross-estate includes the value f any property to which this-section applies in which the deced nt had a qualifying income interest for life . Section 2044 (b) (1) (A) applies section 2044(a) to any property if a deduction as allowed with respect the transfer of such property to the decedent under section 2056(b)(7) . See Estate of Cavenaugh,v . Commissioner , 10 .0 T .C .

40?,ii :~417 (1993), affd . in part on this issue and revd . in part 5 1 F .3d 597, 599-601 (5th Cir . 1995) .

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V r Under section 2056(b)(7)(B)(ii), the relevant questions ar e .whether decedent was entitled to all, the income from th e ,property, payable at least annually,'and whether any person had a poweri :to appoint any part of the property to .any other person .

See Estate of Soberdash v . Commissioner , . T .C . Memo . 1997-362 .

r Respondent argues that the estate is required to include the "value of the assets in the QTIP trust : on decedent's date of deat h in'the value of decedent's gross estate because a QTIP deductio n .under section 2056(b)(7) was allowed for assets funding ,a QTIP :trust, a QTIP election was made, decedent had the right'!,t o receive income from the trust . annually, and decedent did . not .dispose of her income interest in the trust before she died .

The estate argues-that the value of the assets funding the iQTIP trust should not be included'in the value of decedent's gross."estate because decedent did not receive an interest in the .trust or retain it at her death . The, estate argues that decedent never received income or distributions from the trust, was neve r 1cons dered to have an interest in the trust, and to the''exten t it - 2 3 she had an interest in the trust, effectively refuted it before her death .'

I Respondent disputes the estate's contention, arguing tha t there is no evidence that decedent refu ed or disposed of her interest in the trust . Respondent also points to testimony,by, Mr . Price, decedent's lawyer, who testi ied that decedent never disposed of her interest in the QTIP t r st .

We agree with respondent . The fai market value of the .securities in the QTIP trust must be in luded in the value of ; decedent's gross estate . The trust agr ement provided that all income of the trust was to be distribut d to decedent at least, annually and that income was not to acc mulate in the trust . Mr .

Miller's estate made a valid QTIP elect kon, and Mr . Miller' s estate's Form 706 claimed a $1,060,000 marital deduction under section 2056(b)(7) .

Decedent's Form 706 indicated that decedent had been the beneficiary of a distribution for which a section 2056(b)(7) election had been made but did not incl de the value of the assets funding the QTIP trust . Deceden did not dispose of he income interest in the trust before she died .

Although the estate argues that the amounts shouldinot be !'included in the estate because decedent never needed the income, the relevant questions under section 2056(b)(7)(B)(ii) are (whether decedent was entitled to all of the income from th e property, payable at least annually, and whether any person had a 'power=to appoint any part of the property to any other person .

See Estate of(cid:127)Soberdash v . Commissioner , supra . . Thes e ifrequirements were met . The need of the surviving spouse has no . bear'ing on the eligibility for a deduction under section .

f 2056() (7 )4 or the subsequent . inclusion in the surviving! spouse' s grbss .~estate under section 2044 .

Id .

As discussed above, the QTIP`trust assets comprised five Merrill Lynch bank accounts . The parties dispute the fair marke t value ;=,-of the securities that must be-included in the value of decedent's gross estate . The notice valued the securities on .the Idate-of decedent's death at $546,702 . Respondent argues that this is the amount that must be included under .section 2044 .

Respondent does not point to any other evidence in the record !supporting this calculation .

The estate argues that respondent's calculation is,'incorrect and values the securities at $526,758 . The estate contends that respondent overstates the value of the securities becaus e I respondent counts 'certain securities in one ' of the QTIP trust's jt~ accounts twice .

There is no evidence in-the record concerning the fair market value of the securities on May 28, 2003, the date of decedent's death . However, the record does contain account } statements for the five Merrill Lynch accounts for the period ending May .30, 2003 . The May 2003 account statements-for -the accounts at issue, stipulated by the parties, do not indicate that any securities were counted more tIhan once in determining the value of the account .

The statement for account No . 7225 is incomplete . However, the account statement for account No . 8 135 includes values fort ' both account Nos . 8135 and 7225 . The a ccount statement fore, :

; account No . 8135 values account No . 722 5 at $202,8505 and account No . 8135 at $102,0511, for a total of $3 04,(cid:127)902 ., The account statement for account No . 8136 values t hat account at $69,151 .

The account statement for account No . 8 137 values that account at $88,192 .- Lastly the account statement for account No . 8138!'. ) values that account at $70,980 . Thes e statements value the fiv e accounts at $533,225 . Accordingly, dec edent's-gross estate i s increased by $533,225 pursuant to section 2044 :

'The value of account No . 7225 ($202,850) in the account statement for account No . 8135 matches 6 summary contained in'the aforementioned incomplete account statenent .for_account No . 7225 .

'The $1 difference is due to rounding .

,III .

Decedent's Contributions to MFL P Lastly we determine whether .the~cash and securities` deceden t !transferred to MFLP in April 2002 and May 2003 must be included inthe,value of decedent's gross estate under section 2036 at :their-fair market value or are entitled to a discount .

Decedent's gross estate included 920 partnership units in MFLP .

The 920 partnership units were valued at $2,589,118 after application of a 35-percent discount . Respondent does no t contest the amount of the discount that the estate claimed on decedent's estate's Form 706 . Rather, respondent argues that th e estate is not entitled to any discount and must include,the ful l value :,of the transferred assets in the value-of the gross estate .

The purpose of .section 2036 is to include in a decease d :taxp:ayer's gross estate inter vivos transfers that, were -testamentary .

United States v . Estate of Grace , 395 U .S . 31 6 Section 2036(a) generally provides that if a decedent madeian inter vivos transfer of property,(cid:127)other .than a bona fide sale for adequate and full consideration, and retained certai n ,enumerated rights or interests in theirproperty which were not 'relinquished until death, the full value of the transferre d property will be included in the value of the decedent 's gros s ;'estate . Section 2036(a) is applicable when three conditions ar e ,;met : (1) The decedent made an inter vivos transfer of property ; ii (2)1the decedent's transfer was not aibona fide sale for adequate ji.

and full consideration ; and (3 ) the decedent retained an inte re st or right enumerated in section 2036 ( a)(1) or ( 2) or (b ) in the !

transferred property which she did not relinquish before he r death .

Estate of Bongard v . Commissioner , 124 T .C . 95, 11 2 (2005) The bona fide sale for adequate an d full consideratio n exception is limited to a transfer of property where th e transferor " has received benefit in full consideration in a genuine arm ' s length transaction" . Estate of Goetchius v .

Commissioner , 17 T .C . 495, 503 ( 1951) .

In Estate of Bongard~ v .- Commissioner , supra at 118, we held tha t the exception for a bon a fide sale for an adequate and full cons ideration in money o r money's worth is satisfied in the conte kt of a family limited' partnership-- where the record establishes the existence of a legitimate and significantnontax reason for reating(cid:127)the family limited partnership , and the transferors received partnership interests proportionate to the value of the, property transferred . Commissioner , * * * [T .C . Memo . 2003 - 309] . The objective evidence must indicate that the no tax reason was a significant factor, that motivated the -partnership's creation . *. * * motivation , not a theoretical justification .

A significant pur ose must be an actual See, e .g . Estate of Stone v .

The bona fide sale exception is not applicable " where the .1 facts fail to establish that the transaction was motivated ba legitimate and significant nontax purpose . ."

Id . . In Estate-of Bongard v . Commissioner , supra at 118 - 119, . we listed a number .of factors that support such a finding , including, - .28 - the taxpayer's standing .on both sides-of the transaction, * * * the taxpayer's financial dependence on distributions from the partnership, * * * the partners' commingling of partnership funds with their own ; * *(cid:127)* and the taxpayer's actual failure to transfer the property to the partnership . * * * Respondent argues that decedent's transfer of assets to MFLP 1is not exempt from the application of section 2036(a) because the transfer did not constitute a ,bona fide sale for adequate an d ,full consideration . Respondent points to the following factor s s evidence that the transfer was not :bona fide : (1) MFLP's lac k of a functioning business operation ; (2) the delay in making rcontributions to MFLP after MFLP was formed and the partnership agreement was signed ; (3) the type of assets transferred ; (4) decedent' s age ; (5) that decedent stood on both sides of the transaction ; (6) decedent's failure to retain sufficient asset s outside of MFLP ; and (7) the stated reason for MFLP's formation .

The estate argues that decedent's transfers to MFLP wer e ,'bona fide sales for adequate and full consideration . The estat e ,;contends that there were . legitimate and substantial nontax business reasons for the creation of MFLP, including asset protection, succession of management, centralized management, and !continuation of the family's investment strategy . The estate points out that the securities were actually transferred to MFL P and'never commingled with decedent's personal assets, an d partnership formalities were satisfied . We will analyze each contribution separately . "~~ A .

April 2002 Contribution s 29 - We agree with the estate that decedent's April 2002 transfers to MFLP satisfy the bona fide sale for adequate and full consideration exception-and are no governed by section, 2036 . Decedent had legitimate and subs antial nontax busines s reasons for forming MFLP and for contri uting securities in Apri l 2002 . See Estate of Mirowski v . Commis Toner, T .C . Memo . 2008- 74 ; Estate of Schutt v . Commissioner , T .C . Memo . 2005-126 .

Decedent established and funded MFLP to ensure that her assets continued to be managed according to Mr . Miller's investment philosophy .

Mr . Price, Virgil G ., and Donald a,l testified credibl y about Mr . Miller's investment strategy . Mr . Price specificall y testified that Mr . Miller had been char :ing stocks by hand sinc e the beginning of their business relationship and would often bring detailed records with him when_th .two met . We find credible the witnesses' testimony that he driving force behind decedent's desire to form MFLP was-to c ntinue the-management of family assets in accordance with Mr . Miller's investment strategy .

MFLP did not hold investments pass'vely, collecting dividends and interest . See Estate of Gore v . Commissioner, T .C .

Memo . 2007-169 ;- Estate of Rosen v . .Comm .ssioner , T .C . Memo . 2006- 115 . Virgil G . testified that he spent about 40 hours per week managing MFLP's assets, and we find his testimony credible .

iBefore contribution, the assets in decedent's trust accounts were Anot regularly traded . However, Virgil G . began monitoring and ,'trading the assets regularly once they were contributed-to MFLP .

Although MFLP earned income monthly from .these sources, :Virgil G . a z :. ~`also .,evaluated stocks daily . See Estate of Schutt v .

"! Commissioner , supra (family limited partnership had a significan t nontax purpose of facilitating the decedent's buy and hold .investment strategy . and assuaging his worry that his heirs would, 'sell his investments after his death)q,,(cid:127) cf . Estate of Jorgensen v .

Commissioner , T .C . Memo . 2009-66 ("There are no special ;,skills 1* * when adhering to a `buy and'hold'(cid:127)strategy, especially when onelpays an investment adviser to recommend what to buy and whe n to S⁶.11 .

11 ) Virgil G . subscribed to a number of trade-publications an d !purchased computer software to assist`in his securities trading , gland v;GM was compensated by MFLP for management services : MFLP !`involved an active securities trading operation closely aligned with Mr . Miller's investment strategy . Decedent wanted he r ilasset's to be traded according to her husband's investment .

philosophy and set up MFLP to do just that . Virgil G . was the only- family member versed in Mr . Miller ' s trading philosophy, an d ;phel,was-given authority to trade "securities on behalf of ~ MFLP .

- 31, - Virgil G . also discussed MFLP with hislsiblings and provide d financial advice .

Respondent contends that the'trades MFLP actually made were not sufficient to qualify MFLP as a legitimate operation .

Respondent relies on Estate of Thompson v . Commissioner , 382 F ; .'3 d 367 (3d Cir . 2004), affg . T .C . Memo . 20 02-246, in support of thi s argument and also argues that MFLP lack ed employees, kept n o books or records, and had no bank .acco nts in its name .

Respondent further contends that the t es of assets transferre d weigh .against a finding of a(cid:127)valid nont ax business purpose for , the transfers . Respondent again points to Estate of Thompson v .

Commissioner , supra , and Estate of Rosen v . . Commissioner , supra , in support of his contention that there was no benefit to b e derived from transfer of the assets-t o MFLP other than favorabl e estate tax treatment .

MFLP's activities need not rise t o the level of a "business " under the Federal income tax laws in or der for the exception under section 2036(a) to apply . See Estate of Mirowski v .

Commissioner ,- supra ; Estate of Stone v . Commissioner, T .C .- Memo .

2003-309 . Respondent's argument concerning the types of assets transferred fails for the same reason . The nontax purpose behin d formation of MFLP was to continue Mr . Miller's investmen t philosophy and to apply it to family assets . This goal could not have been met had decedent not transferred securities to MFLP .I Respondent's reliance on Estate'(cid:127)'ofThompson and Estate o f Rosen is misplaced . In those cases decedents transferred ifproperty that was not, actively :-managed by family limite d partnerships . See Estate of Thompsonl.v . Commissioner , supra at °379 :("The record demonstrates that neither the Turner Partnership ;nor the Thompson Partnership engaged"'in any valid, functioning business enterprise .") ; Estate of-Rosen v . Commissioner , supra 11("For, .the most part, -the-'assets of the LRFLP appear not to have been traded by the LRFLP, which, in part, explains the minimal capital gain income and loss reported by the LRFLP . ." .,) . JAs stated !~above,l MFLP was not a passive . . holder of securities .

;;a;Respondent's contentions concerning decedent' s age ar e ,likewise misplaced . Respondent contends that the transfers wer e made because . decedent and Virgil G . recognized that . decedent's !health was failing . Respondent argues that decedent and Virgil G . ;imade these .transfers .in view:of her failing health in order to !reduce the value of her taxable estate .%% We do .not agree . At the time of the April 2002 transfers, decedent, although dealing with some ;-'chronic conditions, was generally in good health . Neithe r „de'cedent nor her, family expected any significant decline . i n !decedent's health in the' near futur e As stated above, decedent's desire to continue her deceased husband's investment philosophy , is' a significant nontax business C l purpose . Although intrafamily . .transfers are subject to - 33 - ~, heightened scrutiny, they are not barred .

See-Estate of Bonnard v . Commissioner, 124'T .C . at 123 . Decedent was able to ensure that her assets would be managed and invested in a manner that=,' decedent both desired and trusted : her deceased husband's investment strategy . .

Decedent also retained sufficient ssets outside of MFLP :

after the April 2002 contributions such that she did not need : to rely on distributions from MFLP to pay or day-to-day living expenses . Respondent's argument that d cedent did not retain sufficient assets after making the tran fers fails ; decedent` retained almost $1 million in securitie 'in decedent's trust's Merrill Lynch and Fidelity Investments ccounts and also had .

access to the securities in the QTIP tr .ist after the April 2002 ° transfers . Nor do we believe the use of MFLP funds to pay decedent's trust's . margin accounts tain :s decedent's transfers .], This is not an example ofspartnership funds being used to pay' personal expenses of the decedent . Dec dent's trust purchased) stock on margin ; those stocks were late sold .to pay the corresponding margin account .

Decedent's transfers to MFLP in April 2002 satisfy the bona fide sale exception and are therefore entitled to the claimed discount in valuing decedent's gross es ate . See Estate of Mirowski v .~Commissioner , T .C . Memo . 2 .0 8-74 .- We next analyze the May 2003 contributions .

B .

May 2 .003 Contribution s 34 - We agree with respondent that decedent did not have- legitimate and substantial nontax business reasons for the May 12003 transfers . . The, record indicates that the driving force behind the May 2003 transfers was the precipitous decline in ,decedent's health in the weeks before the transfers . The decision to make additional contributions to MFLP in May 2003 wa s made shortly after decedent broke her hip . See Estate o f '' Erickson v . Commissioner , T .C . Memo . 2007-107 . Although deceden t `wa`s generally in good health before . .the :April 2002 transfers, this was .not the case in May 2003 . In addition . to breaking he r 1hp, decedent had just undergone pacemaker implantation . surgery .

Further, decedent's rehabilitation was not progressing, and sh e was forced to return to the hospitalwith congestive heart failure :

The witnesses' testimony that decedent's family hoped for he;ri.,recovery is credible, but her health was in decline . Given the' lapse in time between the April 2002 contributions ; and the May 2003 contributions, the decline in her health and th e ,decision to reduce her taxable estate were clearly the driving forces behind Virgil G .'s decision to make additional contributions to MFLP .

'The estate's argument that decedent contributed the remainder of her assets to MFLP in May, 2003 so that they were managed in accordance with Mr . Miller's 35 - undercut by the fact that decedent had the option of contributing these securities to MFLP 1 year earlier Had decedent wanted al l of her assets managed by Virgil G . in accordance with Mr .- Miller's investment strategy, there wo l ld have been no need to wait until the last weeks of her life t o make additional transfers to MFLP . The May 2003 contri butions,were driven by Virgil G .'s desire to reduce the valu e of decedent's taxabl e estate . Accordingly, there was no sig n ificant nontax reason f or the transfer, and the transfer .. does not qualify as a bona fide sale for adequate and full consideration . See Estate of Erickson v . Commissioner , supra ("It was only after Mrs . Erickson had bee n admitted to the hospital with pneumon i two days before she died, that the partners finally comple ed their transfers .") ; Estate of Rosen v . Commissioner , T .C . Memo 2006-115 ("The fac t that decedent was 88 years old and i n ailing health strongly supports our finding that the transfer of the assets was purel y for the purpose of avoiding Federal estate and gift taxes .") :

.

Because we find that decedent did not have a significant nontax purpose in making the May 2003 transfers, we mus t determine whether decedent retained the possession or enjoymen t of, or the right .to the income from, the property transferred t o MFLP in May 2003 . Sec . 2036(a) .

,It is clear . that when the decision was made to further fun d MFLPin May 2003,- Virgil G ., as trustee of decedent's trust and .as :ogeneral partner of MFLP, knew that MFLP funds would be needed ,to ;pay decedent's estate-tax liabilities . See Estate of Recto r k v . 'Commissioner , T .C . Memo .,2007-367 .1 The May 2003 transfers were driven by Virgil G .'s.desire to decrease the value of ,decedent's taxable estate . After this contribution, decedent did not retain sufficient assets to satisfy her estate ta x ,,liabilities .

See Estate 'of Erickson v . Commissioner , supra ; ,,Estate of Rosen v . Commissioner , supra .

Although the estate argues that the distribution t o decedent's trust in 2004 was simply a'pro rata distribution t o ,MFLP's partners, the funds were used to satisfy decedent's Iestate's tax liability . "[P]art of the `possession or enjoyment' - Jof on'e's assets, is'the assurance that they will be available to ,pay various debts and expenses upon one's death ."

Strangi v .

Commissioner , 417 F .3d 468, 477 (5th(cid:127)Cir . 2005), affg . T .C . Memo .

2003 :-1"45 . That the remaining partners of MFLP received de minimi's amounts as part of the 2004 distribution serves t o .highlight the fact that a large amount of MFLP funds was needed to'satisfy decedent's liabilities . . "Where an individual conveys a(cid:127)11 or nearly all of his or her assets to a trust or r ' partnership," Estate of Rosen v . Commissioner , supra , th e ,likelihood that the individual will have access to the assets is 37, the greatest, id .

Virgil G .'s use of f nds distributed by .MFLP to pay decedent's estate tax liability hows that the final contributions,to MFLP completely deplet d decedent's resources!, See Strangi v . Commissioner , supra at 478 ; Estate of Rector .vj Commissioner , . supra ; Estate of Rosen v . Commissioner, supra .

G . would not distribut e funds to decedent because to do sowoul violate his fiduciary , duties and-would be at odds with the stated goals of MFLP is not credible . It is inconceivable that had decedent recovered an d faced, for example, increased day-to-day living expenses o r catastrophic medical costs, Virgil G ., 's general partner o f MFLP, would not have provided her with access to the securities used to fund MFLP .

We conclude that at the time of the May 2003 transfer t o MFLP decedent retained the economic benefit of the securities t rans e f rred .

See Estate of Jo r g ensen v .

Commissione r , T .C . Me mo .

2009-66 ; Estate of Rector v . Commissioner, supra . Accordingly, the securities transferred are not enti led to the claimed discount and must be included in the va ue of decedent's gross estate at their fair market value . ' 'For purposes of valuing the securities transferred from decedent's trust's Fidelity Investments account to MFLP's Fidelity Investments account in May 2003, we find Virgil G .'s explanation for the discrepancy between the May and June 2003` account statements credible . Accordingly, those transfers wil¹, , be valued according to the June 2003 statement which shows the (continued .

.

s IV .

. . Conclusio n - 3 8 Decedent's estate is increased by the amounts used , ;to fund the QTIP trust .

Decedent's estate is :;entitled to .the claimed ..

discount for the securities transferred to MFLP in April 2002 .

Decedent' s estate is not entitled to the claimed discount for th e !securities transferred to MFLP in May,,,2003 . . The parties' !agreement as to taxes and any deduction for legal fees will b e dealt(cid:127),,with inthe Rule 155 computation .

'Accordingly, Decision will be entere d under Rule 155 .

ii .

. .continued) transfers being made as of May 15, 2003 .

i

1. On January 29, 2004, MFLP made a0pro rata cash distribution atoit's partners : MFLP disbursed $23,913 from its Fidelity Investments account to each of Virgil G ., Gordon, Marcia, and Donald and disbursed $1 .1 million to decedent's . trust . A portio n r'of'the $1 .1 million was . used to pay decedent's estate's-'!Federal and,State estate tax liabilities . .
4. The estate argues that should we ind that decedent was required to include the QTIP in her est to and did not dispose of her income interest , we should take the fair market value of those securities into account in the cc text of . sec . 2036 when evaluating whether decedent retained su ficient funds after funding MFLP .