Thomas Connelly v. United StatesThomas Connelly v. United States
Before SMITH, Chief Judge, GRUENDER and STRAS, Circuit Judges.
Brothers Michael and Thomas Connelly were the sole shareholders of a corporation. The corporation obtained life insurance on each brother so that if one died, the corporation could use the proceeds to redeem his shares. When Michael died, the Internal Revenue Service assessed taxes on his estate, which included his stock interest in the corporation. According to the IRS, the corporation‘s fair market value includes the life insurance proceeds intended for the stock redemption. Michael‘s estate argues otherwise and sued for a tax refund. The district court1 agreed with the IRS, and so do we.
I.
Before Michael died, he and Thomas owned Crown C Corporation, a building-matеrials company in St. Louis. Michael owned 77.18 percent of the 500 shares outstanding (385.9 shares); Thomas owned 22.82 percent (114.1 shares). To provide for a smooth transition of ownership upon either‘s death, the brothers and Crown together entered into a stock-purchase agreement. If one brother died, the surviving brother had the right to buy his shares. If the surviving brother declined, Crown itself had to redeem the shares. In this way, control of the company would stay within the family. The brothers always intended that Crown, not the surviving brother, would redeem the other‘s shares.
The stock-purchase agreement provided two mechanisms for determining the price at which Crown would redeem the shares. The principal mechanism required the brothers to execute a new Certificate of Agreed Value at the end of every tax year, which set the price per share by “mutual agreement.” If they failed to do so, the brothers were supposed to obtain two or more appraisals of fair market value. The brothers never executed a Certificate of Agreed Value or obtained appraisals as required by the stock-purchase agreement. At any rate, to fund the redemption, Crown purchased $3.5 million of life insurance on each brother.
After Michael died in 2013, Crown received the life insurance proceeds and redeemed his shares for $3 million. The actual redemption transaction was part of a larger, post-death agreement between Thomas and Miсhael‘s son, Michael Connelly, Jr., resolving several estate-administration matters. No appraisals were obtained pursuant to the stock-purchase agreement. Instead, the Connellys declared that they had “resolved the issue of the sale price of [Michael‘s] stock in as amicable and expeditious [a] manner as is possible” and that they “have agreed that the value of the stock” was $3 million. That figure effectively valued Crown, based on Michael‘s 77.18 percent shаre, at $3.89 million. The rest of the proceeds, about $500,000, went to fund company operations.
Thomas is the executor for Michael‘s estate. In 2014, the estate filed a tax return reporting that Michael‘s shares were worth $3 million. To value the shares, Thomas relied solely on the redemption payment, rather than treating the life insurance proceeds as an asset that increased the corporation‘s value and hence the value of Michael‘s shares. All told, this resulted in an estate tax of about $300,000, which was paid.
The IRS audited the estate‘s return. It concluded that the estate had undervalued
The estate claims that the redemption transaction, made in furtherance of the stock-purchase agreement, determined the value of Crown for estate-tax purposes, so there is no need to conduct a fair-market-value аnalysis. Alternatively, the estate argues that Crown‘s fair market value should not include the life insurance proceeds used to redeem Michael‘s shares because, although the proceeds were an asset, they were immediately offset by a liability—the redemption obligation. In other words, the proceeds added nothing to Crown‘s value. By contrast, the IRS argues that the stock-purchase agreement should be disregarded and that any calculation of Crown‘s fair market value must account for the proceeds used for redemption.
The district court granted summary judgment to the IRS. The court first concluded that the stock-purchase agreement did not affect the valuation. The court then determined that a proper valuation of Crown must include the life insurance proceeds used for redemption because they were a significant asset of the company. In doing so, the district court declined to follow Estate of Blount v. Commissioner, 428 F.3d 1338 (11th Cir. 2005), relying instead on the tax code, Treasury regulations, and customary valuation principles. The estate appeals.
II.
A federal tax applies to the transfer of a decedent‘s estate, which comprises the gross estate minus applicable deductions.
The parties dispute whether Crown‘s value, and hence the value of Michael‘s shares, should include the life insurance proceeds used for redemption. If not, then the estate is entitled to a refund. If the proceeds should be included, as the district court determined, then the IRS is correct and summary judgment was proper. With this in mind, we review the district court‘s grant of summary judgment de novo. Westerman v. United States, 718 F.3d 743, 746 (8th Cir. 2013). In refund
We first consider whether the stock-purchase agreement controls how the company should be valued. Finding that it does not, we then consider whether a fair-market-value analysis of Crown must include the life insurance proceeds used for redemption. It must.
A.
Generally, the value of any property for tax purposes is determined “without regard to any option, agreement, or other right to acquire ... the proрerty at a price less than the fair market value” or to “any other restriction on the right to sell or use such property.”
But the estate glosses over an important component missing from the stock-purchase agreement: some fixed or determinable price to which we can look when valuing Michael‘s shares. After all, if § 2703 tells us when we may “regard” agreements to acquire stock “at a price less than the fair market value,” we naturally would expect those agreements to say something about value in a definite or calculable way. See Est. of Lauder v. Comm‘r, 64 T.C.M. (CCH) 1643, 1656 (1992) (“It is axiomatic that the offering price must be fixed and determinable under the agreement.“); see also Est. of Amlie v. Comm‘r, 91 T.C.M. (CCH) 1017, 1027 (2006) (reviewing the comparability of price terms to determine whether the agreement satisfied § 2703(b)(3)). Otherwise, why look to the agreement to value the shares?
Further, the Treasury regulation that clarifies how to value stock subject to a buy-sell agreement refers to the price in such agreements and “[t]he effect, if any, that is given to the ... price in determining the value of the securities for estate tax purposes.”
We need not resolve the precise contours of what counts as a fixed or determinable price because, wherever that line may be, the stock-purсhase agreement here falls short given that the brothers and Crown ignored the agreement‘s pricing mechanisms. It suffices for our purposes to think of a determinable price as one arrived at by “formula,” see Gloeckner, 152 F.3d at 213, as by a “fair, objective measure,” see Lauder, 64 T.C.M. (CCH) at 1659, or “calculation,” see True, 390 F.3d at 1213.
Here, the stock-purchase agreement fixed no price nor prescribed a formula for arriving at one. It merely laid out two mechanisms by which the brothers might agree on a price. One was the Certificate of Agreed Value, which appears to be nothing more than price by “mutual agreement“—essentially, an agreement to agree. The other was an appraisal process for determining the fair market value of Crown. Although this second mechanism seems to carry more objectivity, there is nothing in the stock-purchase agreement, aside from minor limitations on valuation factors, that fixes or prescribes a formula or measure for determining the price that the appraisers will reach. Instead, the agreement required оnly that the appointed appraisers “independently determine and submit” their “appraisal[s] of the fair market value of the Company.” The brothers were then supposed to average the results or consult a third appraiser as a tiebreaker. None of this was ever done. See St. Louis Cnty. Bank, 674 F.2d at 1211 (noting that upon death, the provisions of the stock-purchase agreement were not invoked and that post-death conduct may be relevant to understanding the nature of the agrеement). Thus, “under the circumstances of th[is] particular case,” neither price mechanism constituted a fixed or determinable price for valuation purposes. See
Thomas tries to get around this problem by directing us to the price fixed by the redemption transаction—the $3 million that Crown actually paid for Michael‘s shares. In his view, this is an appropriate valuation because the redemption transaction links back to the stock-purchase agreement and was done pursuant to it. We are not convinced. For one, the $3 million price was chosen after Michael‘s death. See
B.
We now consider the fair market value of Michael‘s shares. The key question is whether the life insurance proceeds received by Crown and intended for redemption should be taken into account when determining the сorporation‘s value at the time of Michael‘s death.4 Two principles guide the analysis. The first deals with valuing property in general, and the second addresses companies whose stock prices cannot be readily determined from an exchange, as is the case with closely held corporations.
Generally, the value of property in the gross estate is “the price at which the property would change hands between a willing buyer and a willing seller, neither being undеr any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
To this end, for closely held corporations, the share value “shall be determined by taking into consideration, in addition to all other factors, the value of stock or securities of corporations engaged in the same or a similar line of business which are listed on an exchange.”
But in valuing a closely held corporation, “consideration shall also be given to nonoperating assets, including proсeeds of life insurance policies payable to or for the benefit of the company, to the extent such nonoperating assets have not been taken into account in the determination of net worth, prospective earning power and dividend-earning capacity.”
Section 2042 says that the value of a decedent‘s gross estate includes life insurance proceeds received directly by the estate as well as proceeds received by other beneficiaries under insurance policies in which the decedent “possessed at his death any of the incidents of ownership.” For example, if Michael obtained a life insurance policy for the benefit of Crown, the value of that policy‘s proceeds would be included in Michael‘s gross estate. See
Now, there might be a plausible argument that under § 2042 Michael possessed “incidents of ownership” in the life insurance policy through his controlling-shareholder status. If that were the case, then § 2042 would require that Michael‘s gross estate include the proceeds used for his stock redemption. But that is not the case. Treasury regulation
Still, although § 2042 does not require that the proceeds be included here, it does not exclude them either. We are cautioned to “[s]ee § 20.2031-2(f) for a rule providing that the proceeds of certain life insurance policies shall be considered in determining the value of the decedent‘s stock.”
Wе must therefore consider the value of the life insurance proceeds intended for redemption insofar as they have not already been taken into account in Crown‘s valuation and in light of the willing buyer/seller test. In this sense, the parties agree that this case presents the same fair-market-value issue as Estate of Blount v. Commissioner, 428 F.3d at 1345-46, from the Eleventh Circuit. But they disagree on whether Blount was correctly decided. Like here, Blount involved a stock-purchase agreement for a closely held corporation. Although the court referenced the requirement in
Like the estate in Blount, Thomas argues that life insurance proceeds do not augment a company‘s value where they are offset by a redemption liability. In his view, the money is just passing through and a willing buyer and seller would not account for it. The IRS counters that this assumption defies common sense and customary valuation principles, as reflected in Treasury regulations.
The IRS has the better argument. Blount‘s flaw lies in its premise. An obligation to redeem shares is not a liability in the ordinary business sense. See 6A Fletcher Cyclopedia of the Law of Corporations § 2859 (Sept. 2022 update) (“The redemption of stock is a reduction of surplus, not the satisfaction of a liability.“).
Treating it so “distorts the nature of the ownership interest represented by those shares.” See Est. of Blount v. Comm‘r, 87 T.C.M. (CCH) 1303, 1319 (2004), aff‘d in part and rev‘d in part, 428 F.3d 1338. Consider the willing buyer at the time of Michael‘s death. To own Crown outright, the buyer must obtain all its shares. At that point, he could then extinguish the stock-purchase agreement or redeem the shares from himself. This is just like moving money from one pocket to another. There is no liability to be considered—the buyer controls the life insurance proceeds. A buyer of Crown would therefore pay up to $6.86 million, having “taken into account” the life insurance proceeds, and extinguish or redeem as desired. See
To further see the illogic of the estate‘s position, consider the resulting windfall to Thomas. If we accept the estate‘s view and look to Crown‘s value exclusive of the life insurance proceeds intended for redemption, then upon Michael‘s death, each share was worth $7,720 before redemption.6 After redemption, Michael‘s interest is extinguished, but Thomas still has 114.1 shares giving him full control of Crown‘s $3.86 million value. Those shares are now worth about $33,800 each.7 Overnight and without any material change to the company, Thomas‘s shares would have quadrupled in value.8 This view of the world
contradicts the estate‘s position that the proceeds were offset dollar-by-dollar by a “liability.” A true offset would leave the value of Thomas‘s shares undisturbed. See Cox & Hazen, supra, § 21:2 (“When a corporation purchases its own stock, it has depleted its assets by whatever amount of money or property it gave in exchange for the stock. There is, however, an increase in the proportional interest of the nonselling shareholders in the remaining assets of the corporation.“). In sum, the brothers’ arrangement had nothing to do with corporate
III.
For the foregoing reasons, we affirm the district court‘s grant of summary judgment to the IRS.