Smith v. United States ( 2004 )

United States Court of Appeals
Fifth Circuit
F I L E D
REVISED DECEMBER 8, 2004
IN THE UNITED STATES COURT OF APPEALS November 15, 2004
FOR THE FIFTH CIRCUIT Charles R. Fulbruge III
Clerk
____________________
No. 04-20194
____________________
JOHN DAVID SMITH, Executor of the Estate of Louis R Smith
Deceased
Plaintiff - Appellant
v.
UNITED STATES OF AMERICA
Defendant - Appellee
_________________________________________________________________
Appeal from the United States District Court
for the Southern District of Texas
_________________________________________________________________
Before KING, Chief Judge, and HIGGINBOTHAM and DAVIS, Circuit
Judges.
KING, Chief Judge:
Appellant John David Smith, Executor of the Estate of Louis R.
Smith, brought suit against Defendant United States of America
seeking a refund of federal estate taxes. The Estate claimed it
was owed a partial refund because it overvalued certain retirement
accounts held by the decedent in calculating the total gross estate
and, therefore, overpaid its federal estate taxes. According to
the Estate, the retirement accounts should have been valued at a
discounted amount to reflect the federal income tax liability that
will be triggered when distributions are made from the retirement
accounts to the beneficiaries. The government moved for summary
judgment, arguing that the Estate was not entitled to a federal
estate tax refund because the potential income tax liability to the
beneficiaries should not be considered in valuing those accounts
for federal estate tax purposes. The district court granted
summary judgment in favor of the government, and the Estate now
appeals. For the following reasons, we AFFIRM the judgment of the
district court.
I. BACKGROUND
A. Facts
The decedent, Louis R. Smith, died on March 7, 1997. John
David Smith, the decedent’s son, is the executor of his estate
(the “Estate”). The Estate timely filed a United States Estate
(and Generation-Skipping Transfer) Tax Return (Form 706)
reflecting an estate tax balance due in the amount of
$140,358.00, which the Estate promptly paid in full. In its tax
return, the Estate reported two retirement accounts that the
decedent had accumulated while employed by Phillips Petroleum
Company: (1) the Phillips Petroleum Company Thrift Plan (the
“Thrift Plan”), which the Estate valued at $725,550.00; and (2)
the Phillips Petroleum Company Long Term Stock Plan (the “Stock
Plan”), which the Estate valued at $42,808.00 (referred to
collectively as the “Retirement Accounts”). The Retirement
Accounts were comprised of marketable stocks and bonds.
On October 30, 1999, the Estate timely filed a Claim for
2
Refund and Request for Abatement (Form 843), seeking a refund in
the amount of $78,731.00 plus accrued interest. In its claim,
the Estate averred that the “refund should be allowed because the
executor made an overpayment [sic] estate tax due to an error in
the calculation and the valuation of the gross estate of the
decedent.” In addition to its refund claim, the Estate also
filed a supplemental United States Estate (and Generation-
Skipping Transfer) Tax Return (Form 706), which discounted the
value of the Retirement Accounts by thirty percent. In an
attachment to the return, the Estate explained that the thirty-
percent discount reflected the amount of income taxes that would
be paid by the beneficiaries upon the distribution of the assets
in the Retirement Accounts. Specifically, the Thrift Plan was
discounted to $507,885.00 and the Stock Plan was discounted to
$29,966.00. This resulted in an estate tax liability of only
$61,627.00. By letter dated July 13, 2001, the Internal Revenue
Service disallowed the Estate’s refund claim, stating that “[n]o
discount for taxes due, now or in the future, is allowable in
valuing the assets in dispute.”
B. Procedural History
On May 29, 2002, the Estate timely filed a complaint against
the United States in the United States District Court for the
Southern District of Texas, seeking a refund of federal estate
tax. The United States moved for summary judgment, arguing that
3
the Estate was not entitled to discount the value of the
Retirement Accounts to reflect income taxes payable by the
beneficiaries upon receipt of distributions from the accounts.
Additionally, the United States asserted that the Retirement
Accounts should be valued at their fair market value as
determined by the willing buyer-willing seller standard.
The district court granted the government’s motion for
summary judgment. In doing so, the court specifically declined
to consider any other factors that could affect the value of the
Retirement Accounts as set forth in the expert report included in
the Estate’s response to the motion for summary judgment.1 The
court reasoned that the Estate failed to raise such factors or
refer to any evidence supporting them in its response. Thus, the
court concluded that the sole issue was whether, for estate tax
purposes, “the retirement accounts should be priced at their face
value or whether they should be discounted to reflect the thirty
percent income tax to be incurred by the beneficiaries upon
distribution.” Estate of Smith v. United States, 300 F. Supp. 2d
474, 476 (S.D. Tex. 2004). Applying the willing buyer-willing
1
The expert opinion stated, inter alia, that under the
hypothetical willing buyer-willing seller test, “all relevant facts
and elements of value shall be considered.” In the firm’s view,
that included: (1) the lack of marketability; (2) the twenty-
percent income tax withholding resulting from a liquidation of the
Retirement Accounts; (3) the possible transferee liability that may
be asserted against the purchaser of interests in the Retirement
Accounts; and (4) the need for a reasonable profit in order to
induce a willing buyer to enter into the transaction.
4
seller test, the court reasoned that while the Retirement
Accounts may generate a tax liability for the beneficiaries in
this case, a hypothetical willing buyer would not take that
income liability into consideration when purchasing the
underlying securities but would simply pay the value of the
securities as determined by the applicable securities exchange
prices. The court further stated that 26 U.S.C. § 691(c)
ameliorates the double tax (the estate and income taxes) by
allowing the taxpayer a deduction in the amount of the estate tax
attributable to the particular asset. Accordingly, the court
found that the Retirement Accounts were properly valued at their
fair market value as reflected by the applicable securities
exchange prices on the date of the decedent’s death (not
including a discount for the tax payable by the beneficiaries
upon distribution from the accounts). Since there was no dispute
between the parties that the Estate’s initial tax return
reflected the cash value of the Retirement Accounts, the court
concluded that there was no material question of fact.
The Estate timely appealed to this court, arguing that the
district court erred: (1) by refusing to consider evidence
properly included in the summary judgment record--i.e., the
additional factors that could affect the value of the Retirement
Accounts as set forth in the expert opinion provided by the
Estate; and (2) when valuing the Retirement Accounts, failing to
apply a discount for the federal income tax liability that will
5
be triggered upon distributions from the Retirement Accounts to
the beneficiaries.
II. STANDARD OF REVIEW
This court reviews the grant of summary judgment de novo.
Baton Rouge Oil & Chem. Workers Union v. ExxonMobil Corp., 289
F.3d 373, 376 (5th Cir. 2002). “Summary judgment is proper ‘if
the pleadings, depositions, answers to interrogatories, and
admissions on file, together with the affidavits, if any, show
that there is no genuine issue as to any material fact and that
the moving party is entitled to a judgment as a matter of law.’”
Skotak v. Tenneco Resins, Inc., 953 F.2d 909, 912 (5th Cir. 1992)
(quoting FED. R. CIV. P. 56(c)); accord Celotex Corp. v. Catrett,
477 U.S. 317, 322 (1986). There is a genuine dispute about a
material fact if “the evidence is such that a reasonable jury
could return a verdict for the nonmoving party.” Skotak, 953
F.2d at 912 (quoting Anderson v. Liberty Lobby, Inc., 477 U.S.
242, 248 (1986) (internal quotation marks omitted)). In weighing
the evidence, a court must review the facts in the light most
favorable to the non-moving party. Anderson, 477 U.S. at 255.
III. ANALYSIS
A. Summary Judgment Evidence
The Estate argues that the district court improperly refused
to consider certain evidence even though the Estate repeatedly
made references to it. The summary judgment evidence in question
6
consisted of the additional factors that the expert opinion
stated should be considered in valuing the Retirement Accounts:
(1) the lack of marketability; and (2) the need for a reasonable
profit in order to induce a willing buyer to enter into a
transaction.2
To survive summary judgment, the nonmoving party must submit
or identify evidence in the summary judgment record (such as
affidavits, depositions, answers to interrogatories, or
admissions on file) that designate specific facts showing there
is a genuine issue of fact. Celotex Corp., 477 U.S. at 324;
Malacara v. Garber, 353 F.3d 393, 404 (5th Cir. 2003); Topalian
v. Ehrman, 954 F.2d 1125, 1131 (5th Cir. 1992), reh’g denied, 961
F.2d 215 (1992). The nonmovant is also required to articulate
2
The Estate also argues that the district court erred
because it did not consider the expert opinion as a whole. That is
an inaccurate reading of the district court’s opinion, which
specifically states:
While the expert report included in Plaintiff's response
to Defendant's motion raises several additional factors
that could affect the value of the retirement accounts,
Plaintiff failed to raise such factors or refer to any
evidence supporting such factors in its response.
Therefore, those portions of the expert report were not
properly before the Court and must be disregarded.
Estate of Smith, 300 F. Supp. 2d at 476 n.5 (emphasis added).
Combined with the fact that the district court analyzed whether the
“inherent” income tax should be discounted from the value of the
accounts--one of the factors in the expert opinion--it is clear the
district court did not refrain from considering the opinion as a
whole, but only refrained from considering those portions that the
Estate did not refer to in its response. Thus, we only address the
Estate’s argument that the district court erred by not considering
the additional factors cited in the expert opinion.
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the precise manner in which the submitted or identified evidence
supports his or her claim. Ragas v. Tenn. Gas Pipeline Co., 136
F.3d 455, 458 (5th Cir. 1998). Thus, this court has held that
“[w]hen evidence exists in the summary judgment record but the
nonmovant fails even to refer to it in the response to the motion
for summary judgment, that evidence is not properly before the
district court.” Malacara, 353 F.3d at 405; accord Skotak, 953
F.2d at 915.
The additional factors were part of the summary judgment
record since they were part of the expert opinion appended to the
Estate’s response to the government’s motion for summary
judgment. However, the Estate neither referred to the additional
factors nor argued that the factors raised a genuine issue of
material fact. Furthermore, the sort of vague and general
references that the Estate made in its response were insufficient
to put the portions of the opinion that discussed the additional
factors properly before the district court.3 See Forsyth v.
Barr, 19 F.3d 1527, 1536-37 (5th Cir. 1994), cert. denied, 513
U.S. 871 (1994) (stating that the appellants did not identify the
specific portions of the summary judgment evidence to support
their claim when they “offered only vague, conclusory assertions
3
The Estate’s statements include: (1) using the word
“factors” in its formulation of the issue; (2) arguing that the
court generally takes into account factors that are limited to the
characteristics of a particular asset; and (3) repeating the phrase
“inherent tax liability and legal restrictions” in its response.
8
that their ‘evidentiary materials’” supported their claim and
raised a genuine issue of fact). Moreover, the Estate simply
failed to articulate the precise manner in which the additional
factors would affect valuing the Retirement Accounts. We
therefore conclude that the district court properly refused to
consider the additional factors contained in the expert opinion.
B. Valuation Method
The Estate also argues that the district court erred in the
method it used in valuing the Retirement Accounts. Specifically,
the Estate contends that the Retirement Accounts’ lack of
marketability and the “inherent” income tax liability should have
been factored in when valuing such accounts. The Estate also
contends that 26 U.S.C. § 691(c) does not preclude a discount for
inherent tax liability when valuing the Retirement Accounts. We
address each of the Estate’s arguments in turn.
1. Lack of Marketability
The Estate’s argument that the Retirement Accounts’ lack of
marketability should have been factored into its value fails
because, as our discussion of the evidentiary issue suggests,
the Estate made this argument for the first time on appeal.
“Issues raised for the first time on appeal are not reviewable by
this court unless they involve purely legal questions and failure
to consider them would result in manifest injustice.” Varnado v.
Lynaugh, 920 F.2d 320, 321 (5th Cir. 1991) (quoting United States
9
v. Garcia-Pillado, 898 F.2d 36, 39 (5th Cir. 1990)) (internal
quotation marks omitted). The Estate did not argue in the
proceedings below that lack of marketability is a factor that
should be considered in valuing the Retirement Accounts. More
specifically, the Estate failed to mention that marketability
should be a factor in discounting the Retirement Accounts in its
refund claim, complaint, response to the government’s motion for
summary judgment, or surreply. In fact, the refund that the
Estate seeks--thirty percent of the Retirement Accounts’ value--
is based solely on a discount for the Retirement Accounts’
“inherent tax liability” and not for its lack of marketability.
Accordingly, we abstain from considering the Estate’s argument
since the Estate raised it for the first time on appeal.
2. Income Tax Liability
We now turn to whether the value of the Retirement Accounts
should have been discounted to reflect the potential federal
income tax liability to the beneficiaries upon distribution from
the accounts. Before discussing the valuation method of the
Retirement Accounts, it is useful to discuss the nature of those
accounts and the tax treatment they are afforded by the Internal
Revenue Code with respect to the decedent and his beneficiaries.
The Retirement Accounts here were funded with tax-deferred
compensation. In other words, the income used to purchase the
assets in the Retirement Accounts has never been subject to
income tax. Had the decedent’s Retirement Accounts been
10
distributed to him during his life, he would have paid a federal
income tax on the distribution. See, e.g., 26 U.S.C.
§ 402(b)(2).4 However, the Retirement Accounts remained intact
at the date of the decedent’s death. The contents of the
accounts, which were not properly includible in computing the
decedent’s taxable income for the taxable year ending on the date
of his death or for any previous taxable year, are classified
under § 691(a) of the Internal Revenue Code as “income in respect
of a decedent.” 26 U.S.C. § 691(a)(1); 26 C.F.R. § 1.691(a)-1.
To preserve the taxability of items of income in respect of a
decedent in the hands of the beneficiaries, such items are
excepted by statute from the usual step-up in basis to fair
market value. 26 U.S.C. § 1014(c). Income in respect of a
decedent must be included in the gross income, for the taxable
year when received, of the decedent’s beneficiaries. 26 U.S.C.
§ 691(a)(1)(B). Thus, when the Retirement Accounts are actually
distributed, the beneficiaries must pay an income tax on the
proceeds. Id.
Even though the federal income tax on the income used to
4
Section 402(b)(2) provides in pertinent part:
(b) Taxability of beneficiary of nonexempt
trust. . . .
(2) Distributions. The amount actually
distributed or made available to any
distributee by any trust described in
paragraph (1) shall be taxable to the
distributee, in the taxable year in which
so distributed or made available . . . .
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purchase the assets in the Retirement Accounts was thus deferred,
the accounts are still considered part of the decedent’s estate
for federal estate tax purposes. 26 U.S.C. § 2039(a). As such,
the Estate must pay an estate tax on the value of the Retirement
Accounts. Id.
To summarize, then, the Retirement Accounts are subject to
an estate tax, and in addition, an income tax will be assessed
against the beneficiaries of the accounts when the accounts are
distributed. To compensate (at least partially) for this
potentially double taxation, Congress enacted § 691(c) of the
Internal Revenue Code, which grants the recipient of income in
respect of a decedent an income tax deduction equal to the amount
of federal estate tax attributable to that asset.5 26 U.S.C.
§ 691(c). Therefore, in our scenario, the decedent’s
5
Section 691(c) provides:
(c) Deduction for estate tax.
(1) Allowance of deduction.
(A) General rule. A person who includes
an amount in gross income under
subsection (a) shall be allowed, for the
same taxable year, as a deduction an
amount which bears the same ratio to the
estate tax attributable to the net value
for estate tax purposes of all the items
described in subsection (a)(1) as the
value for estate tax purposes of the
items of gross income or portions thereof
in respect of which such person included
the amount in gross income (or the amount
included in gross income, whichever is
lower) bears to the value for estate tax
purposes of all the items described in
subsection (a)(1).
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beneficiaries will be allowed a deduction in the amount of
federal estate tax paid on the Retirement Accounts. Finally, the
deduction is allowed in the same year the income is realized--
that is, when the Retirement Accounts are actually distributed.
See 26 U.S.C. § 691(c)(1)(A).
Against this backdrop, we consider the Estate’s argument and
apply the valuation method specified by the Internal Revenue
Code. Section 2031 provides that the value of the decedent’s
gross estate is determined by including the value at the time of
his death of all of his property. 26 U.S.C. § 2031(a). “The
value of every item of property includible in a decedent’s gross
estate . . . is its fair market value . . . .” Treas. Reg.
§ 20.2031-1(b) (2004); accord Cook, 349 F.3d at 854. Fair market
value is defined as “the price at which the property would change
hands between a willing buyer and a willing seller, neither being
under any compulsion to buy or to sell and both having reasonable
knowledge of the relevant facts.” Treas. Reg. § 20.2031-1(b);
accord United States v. Cartwright, 411 U.S. 546, 551 (1973);
Cook, 349 F.3d at 854. “The buyer and seller are hypothetical,
not actual persons.” Estate of Jameson v. Commissioner, 267 F.3d
366, 370 (5th Cir. 2001). This court has stated that “[w]hen
applying the willing buyer-willing seller test . . . the
‘“willing seller” is not the estate itself, but is a hypothetical
seller.’” Adams v. United States, 218 F.3d 383, 386 (5th Cir.
2000) (per curiam) (quoting Estate of Bonner v. United States, 84
13
F.3d 196, 198 (5th Cir. 1996)) (alterations in original). In
applying this test, the tax court has specifically refused to
view the sale as one between the estate and the beneficiary.
Estate of Robinson v. Commissioner, 69 T.C. 222, 225 (1977). In
Estate of Robinson, the estate asset at issue was an installment
note which constituted income in respect of a decedent. The
estate argued that in order to determine the fair market value of
the note for purposes of the estate tax, one must take into
consideration the income tax payable by the beneficiaries as the
installments mature, rather than valuing the note under the
willing buyer-willing seller test. Id. The tax court disagreed,
holding that Treas. Reg. § 20.2031-1(b) explicitly provides that
property, such as the note at issue,
is to be valued, for estate tax purposes, under an
objective approach applying the willing buyer-willing
seller test. There is no support in the law or
regulations for [the estate’s] approach which is
designed to arrive at the value of the transfer as
between the individual decedent and his estate or
beneficiaries.
Id.
In its brief, the Estate argues that the fair market value
of the Retirement Accounts should reflect its “inherent income
tax liability.” Specifically, it asserts that the value of the
assets in the Retirement Accounts should have been discounted to
reflect the federal income tax liability to the beneficiaries
upon distribution from the accounts. The Estate fails to
acknowledge that the willing buyer-willing seller test is an
14
objective one. Thus, the hypothetical parties are not the Estate
and the beneficiaries of the Retirement Accounts. Accordingly,
we do not consider that the particular beneficiaries in this case
are receiving income in respect of a decedent and will eventually
pay tax on the distributions from the Retirement Accounts because
doing so would alter the test from a hypothetical sale into an
actual one. Applying the test appropriately then entails looking
at what a hypothetical buyer would pay for the assets in the
Retirement Accounts.6 The Retirement Accounts consist of stocks
and bonds. A hypothetical buyer would pay the value of the
securities as reflected by the applicable securities exchange
prices. A hypothetical seller would likewise sell the securities
for that amount. Correctly applying the willing buyer-willing
seller test demonstrates that a hypothetical buyer would not
consider the income tax liability to a beneficiary on the income
in respect of a decedent since he is not the beneficiary and thus
would not be paying the income tax.
The Estate’s position is further eroded when one considers
what income tax rate should be employed under the Estate’s
argument. In this case, the Estate’s position on the applicable
rate is, at best, muddled. In the Estate’s refund claim, the
Estate asserted that the applicable tax rate would be thirty
6
As the parties recognize, the Retirement Accounts, by
their terms, cannot be sold. For this reason, the debate here is
over the value of the constituent assets.
15
percent, and it was specifically on the basis of this rate that
the claimed discount was predicated. The valuation expert’s
opinion included in the Estate’s summary judgment evidence notes
that when the Retirement Accounts are distributed, the respective
payors will be obligated to withhold twenty percent of the amount
of any distribution for application against any income tax
liability of the beneficiary. The opinion goes on to state that
the beneficiary’s income tax liability could exceed the twenty
percent withheld “in almost all cases.” The valuation opinion
does not, however, settle on a specific tax rate to be used for
the purpose of valuing the Retirement Accounts. At oral
argument, in response to a question about how the thirty-percent
discount in the refund claim was arrived at, counsel for the
Estate stated (inconsistently with the Estate’s refund claim)
that the thirty-percent discount took into account all the
factors identified in the expert’s opinion, including the lack of
marketability and the “inherent income tax.” The muddle in the
record and at oral argument about the tax rate stems from the
fact the Internal Revenue Code is devoid of a provision that
would flesh out the Estate’s position, putting the Estate in the
position of having to make up a theory to support the amount of
its claimed discount. The theory is predicated on the fact that
a beneficiary will have to pay income tax on a distribution from
the Retirement Accounts, but the beneficiary’s actual tax rate
for some future year when the distribution is made is simply
16
unknown. The Estate’s argument is exactly the kind of
beneficiary-specific inquiry, with the added feature of
speculation on the future, that the hypothetical willing buyer-
willing seller test precludes.
The Estate, however, contends there is a recent trend, as
evidenced by several cases, of considering potential tax
liability in valuation.7 See Dunn v. Commissioner, 301 F.3d 339
(5th Cir. 2002); Estate of Jameson, 267 F.3d at 366; Eisenberg
v. Commissioner, 155 F.3d 50 (2d Cir. 1998); Estate of Davis v.
Commissioner, 110 T.C. 530 (1998). In those cases, the estate
asset at issue was stock in a closely-held corporation, and the
court was faced with the question whether the capital gains tax
that would be payable upon the sale of assets held by the
corporation would factor into the fair market value of the
corporation’s stock. See Dunn, 301 F.3d at 339; Estate of
Jameson, 267 F.3d at 366; Eisenberg, 155 F.3d at 50; Estate of
Davis, 110 T.C. 530. As the government urges, these cases are
distinguishable. First, this case involves a different sort of
asset–-i.e., Retirement Accounts containing marketable stocks and
bonds. Thus, the rationale in those cases, that a hypothetical
7
This so-called “trend,” as discussed in the same cases
cited by the Estate, is attributable to the abrogation, by the Tax
Reform Act of 1986, of the General Utilities doctrine, General
Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935),
dealing with corporate liquidations. See Dunn, 301 F.3d at 339;
Estate of Jameson, 267 F.3d at 366; Eisenberg, 155 F.3d at 50;
Estate of Davis, 110 T.C. 530.
17
buyer would discount the price of stock in a closely-held
corporation to reflect the capital gains taxes that would be
payable by the buyer in the event of a subsequent liquidation of
the corporation, is wholly inapplicable here. Second, while the
stock considered in the above cases would have built-in capital
gains even in the hands of a hypothetical buyer, the Retirement
Accounts at issue here would not constitute income in respect of
a decedent in the hands of a hypothetical buyer. Income in
respect of a decedent can only be recognized by: (1) the estate;
(2) the person who acquires the right to receive the income by
reason of the decedent’s death; or (3) the person who acquires
the right to receive the income by bequest, devise, or
inheritance. 26 U.S.C. § 691(a)(1). Thus, a hypothetical buyer
could not buy income in respect of a decedent, and there would be
no income tax imposed on a hypothetical buyer upon the
liquidation of the accounts. Third, as we have seen, Congress
has provided relief, in § 691(c), from the income tax that would
be imposed on the decedent’s beneficiaries in the form of a
deduction for the estate taxes paid with respect to the inclusion
in the gross estate of the Retirement Accounts. In contrast, in
the case of closely-held corporate stock, the capital-gains tax
potential survives the transfer to an unrelated third party, and
Congress has not granted any relief from the secondary tax.
We therefore conclude that the district court did not err in
refusing to consider the potential federal income tax liability
18
to the beneficiaries when valuing the Retirement Accounts. As
the district court stated, Congress has addressed the Estate’s
concerns in § 691(c). The courts have no business improving on
Congress’s efforts.
IV. CONCLUSION
For the foregoing reasons, the judgment of the district
court is AFFIRMED.
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