Hackl, Albert J. v. CIR ( 2003 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
Nos. 02-3093 & 02-3094
ALBERT J. HACKL, SR. and CHRISTINE M. HACKL,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
____________
Appeals from Decisions of the
United States Tax Court
Nos. 6921-00 and 6922-00
____________
ARGUED JUNE 3, 2003—DECIDED JULY 11, 2003
____________
Before FLAUM, Chief Judge, and BAUER and EVANS,
Circuit Judges.
EVANS, Circuit Judge. Most post-retirement hobbies
don’t involve multi-million dollar companies or land re-
tirees in hot water with the IRS, but those are the cir-
cumstances in this case. Albert J. (A.J.) and Christine M.
Hackl began a tree-farming business after A.J.’s retire-
ment and gave shares in the company to family members.
The Hackls believed the transfers were excludable from
the gift tax, but the IRS thought otherwise. The Tax
Court agreed with the IRS, Hackl v. Comm’r, 118 T.C. 279(2002), resulting in a gift tax deficiency of roughly $400,000
for the couple. The Hackls appeal.
2 Nos. 02-3093 & 02-3094
Our story begins with A.J. Hackl’s retirement and
subsequent search for a hobby that would allow him to
keep his hand in the business world, diversify his invest-
ments, and provide a long-term investment for his family.
Tree-farming fit the bill and, in 1995, A.J. purchased
two tree farms (worth around $4.5 million) and con-
tributed them, as well as about $8 million in cash and
securities, to Treeco, LLC, a limited liability company
that he set up in Indiana (Treeco later changed names,
but that doesn’t matter for our purposes, so we’ll refer to
Treeco and its successors as simply Treeco).
A.J. and his wife, Christine, initially owned all of
Treeco’s stock (which included voting and nonvoting
shares), with A.J. serving as the company’s manager. Under
Treeco’s operating agreement, the manager served for life
(or until resignation, removal, or incapacity), had the
power to appoint a successor, and could also dissolve the
company. In addition, the manager controlled any financial
distributions, and members needed his approval to with-
draw from the company or sell shares. If a member trans-
ferred his or her shares without consent, the transferee
would receive the shares’ economic rights but not any
membership or voting rights. Voting members could run
Treeco during any interim period between managers,
approve any salaries or bonuses paid by the company,
and remove a manager and elect a successor. With an 80-
percent majority, voting members could amend the Arti-
cles of Organization and operating agreement and dissolve
the company after A.J.’s tenure as manager. Both the
voting and the nonvoting members had the right to ac-
cess Treeco’s books and records and to decide whether
to continue Treeco following an event of dissolution (such
as the death, resignation, removal, retirement, bankruptcy,
or insanity of the manager). During A.J.’s watch, Treeco
has operated at a loss and not made any distributions to
its stockholders. While Treeco has yet to turn a profit,
Nos. 02-3093 & 02-3094 3
A.J. was named “Tree Farmer of the Year” in Putnam
County, Florida, in 1999.
Shortly after Treeco’s creation, A.J. and Christine be-
gan annual transfers of Treeco voting and nonvoting
shares to their children, their children’s spouses, and a
trust set up for the couple’s grandchildren. After January
1998, 51 percent of the company’s voting shares were in
the hands of the couple’s children and their spouses. The
Hackls attempted to shield the transfers from taxation
by treating them as excludable gifts on their gift tax
returns. While the Internal Revenue Code imposes a tax
on gifts, 26 U.S.C. § 2501(a), a donor does not pay the tax
on the first $10,000 of gifts, “other than gifts of future
interests in property,” made to any person during the
calendar year, 26 U.S.C. § 2503(b)(1). Unfortunately for
the Hackls, the IRS thought that the transfers were fu-
ture interests and ineligible for the gift tax exclusion.
The Hackls took the dispute to the Tax Court which, as
we said, sided with the IRS.
The Hackls contend that the Tax Court was in error.
Although we owe no special deference to the Tax Court
on a legal question, when we consider the application of
the legal principle to the facts we will reject the Tax
Court decision only if it is clearly erroneous. See Seggerman
Farms, Inc. v. Comm’r, 308 F.3d 803, 805 (7th Cir. 2002)
(quoting Whittle v. Comm’r, 994 F.2d 379, 381 (7th Cir.
1993)). Deficiencies determined by the Commissioner
are presumed to be correct, and the taxpayers bear the
burden of proving otherwise. See Reynolds v. Comm’r,
296 F.3d 607, 612 (7th Cir. 2002) (citing Pittman v. Comm’r,
100 F.3d 1308, 1313 (7th Cir. 1996)).
The crux of the Hackls’ appeal is that the gift tax
doesn’t apply to a transfer if the donors give up all of
their legal rights. In other words, the future interest
exception to the gift tax exclusion only comes into play if
4 Nos. 02-3093 & 02-3094
the donee has gotten something less than the full bundle
of legal property rights. Because the Hackls gave up all
of their property rights to the shares, they think that
the shares were excludable gifts within the plain mean-
ing of § 2503(b)(1). The government, on the other hand,
interprets the gift tax exclusion more narrowly. It ar-
gues that any transfer without a substantial present
economic benefit is a future interest and ineligible for
the gift tax exclusion.
The Hackls’ initial argument is that § 2503(b)(1) auto-
matically allows the gift tax exclusion for their transfers.
The Hackls argue that their position reflects the
plain—and only—meaning of “future interest” as used in
the statute, and that the Tax Court’s reliance on mate-
rials outside the statute (such as the Treasury regulation
definition of future interest and case law) was not
only unnecessary, it was wrong. We disagree. Calling any
tax law “plain” is a hard row to hoe, and a number of
cases (including our decision in Stinson Estate v. United
States, 214 F.3d 846 (7th Cir. 2000)) have looked beyond
the language of § 2503(b)(1) for guidance. See, e.g., United
States v. Pelzer, 312 U.S. 399, 403-04 (1941), and Comm’r
v. Disston, 325 U.S. 442, 446 (1945) (stating that regula-
tory definition of future interest has been approved repeat-
edly). The Hackls do not cite any cases that actually
characterize § 2503(b)(1) as plain, and the term “future
interest” is not defined in the statute itself. Furthermore,
the fact that both the government and the Hackls have
proposed different—yet reasonable—interpretations of
the statute shows that it is ambiguous. Under these
circumstances, it was appropriate for the Tax Court to
look to the Treasury regulation and case law for guidance.
Hedging their bet, the Hackls say that the applicable
Treasury regulation supports the conclusion that giving
up all legal rights to a gift automatically makes it a pre-
sent interest. The applicable Treasury regulation states
Nos. 02-3093 & 02-3094 5
that a “future interest” is a legal term that applies to
interests “which are limited to commence in use, posses-
sion, or enjoyment at some future date or time,” Treas. Reg.
§ 25.2503-3. The regulation also provides that a present
interest in property is “[a]n unrestricted right to the
immediate use, possession, or enjoyment of property or
the income from property (such as a life estate or term
certain).” We don’t think that this language auto-
matically excludes all outright transfers from the gift
tax. See also Hamilton v. United States, 553 F.2d 1216,
1218 (9th Cir. 1977).
We previously addressed the issue of future interests
for purposes of the gift tax exclusion in Stinson Estate.
In that case, forgiveness of a corporation’s indebtedness
was a future interest outside the gift tax exclusion be-
cause shareholders could not individually realize the gift
without liquidating the corporation or declaring a divi-
dend—events that could not occur upon the actions of
any one individual under the corporation’s bylaws. See
214 F.3d at 848. We said that the “sole statutory distinc-
tion between present and future interests lies in the
question of whether there is postponement of enjoyment
of specific rights, powers or privileges which would be
forthwith existent if the interest were present.” Id. at 848-
49 (quoting Howe v. United States, 142 F.2d 310, 312
(7th Cir. 1944)). In other words, the phrase “present inter-
est” connotes the right to substantial present economic
benefit. See Fondren v. Comm’r, 324 U.S. 18, 20 (1945).
In this case, Treeco’s operating agreement clearly fore-
closed the donees’ ability to realize any substantial pre-
sent economic benefit. Although the voting shares that
the Hackls gave away had the same legal rights as
those that they retained, Treeco’s restrictions on the
transferability of the shares meant that they were essen-
tially without immediate value to the donees. Granted,
Treeco’s operating agreement did address the possibility
6 Nos. 02-3093 & 02-3094
that a shareholder might violate the agreement and sell
his or her shares without the manager’s approval. But, as
the Tax Court found, the possibility that a shareholder
might violate the operating agreement and sell his or
her shares to a transferee who would then not have
any membership or voting rights can hardly be called a
substantial economic benefit. Thus, the Hackls’ gifts—while
outright—were not gifts of present interests.
The Hackls protest that Treeco is set up like any
other limited liability corporation and that its restric-
tions on the alienability of its shares are common in
closely held companies. While that may be true, the
fact that other companies operate this way does not
mean that shares in such companies should automatically
be considered present interests for purposes of the gift
tax exclusion. As we have previously said, Internal Revenue
Code provisions dealing with exclusions are matters of
legislative grace that must be narrowly construed. See
Stinson Estate, 214 F.3d at 848. The onus is on the taxpay-
ers to show that their transfers qualify for the gift tax
exclusion, a burden the Hackls have not met.
The decision of the Tax Court is AFFIRMED.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—7-11-03