• Tax Court Reaches Different Results in Two Gift Cases Arising from Similar Facts
  • December 28, 2015 | Authors: Thomas N. Lawson; Alan J. Tarr
  • Law Firms: Loeb & Loeb LLP - Los Angeles Office ; Loeb & Loeb LLP - New York Office
  • The Tax Court very recently decided two interesting gift tax cases involving the Redstone family and the stock of National Amusement, Inc. (“NAI”). NAI was incorporated in 1959 by Mickey Redstone, who wished to consolidate his holdings of various companies that owned drive-in movie theatres. Mickey’s sons, Sumner and Edward, were also part owners of these various entities. They all transferred their interests to NAI, with Mickey’s contribution accounting for 47.88% of the total value, Sumner’s for 26.49% and Edward’s for 25.63%. Despite contributing nearly one-half of the total value, Mickey caused the shares of NAI to be issued 1/3 to each of himself, Sumner and Edward. Each of the three had 100 shares issued in his name, but all of the stock certificates were held by NAI.

    By 1971, Edward was unhappy with his role in the family business and wished to have his 1/3 of the shares re-purchased by the Company. Mickey and the company took the position that although 1/3 of the shares were registered in Edward’s name, a portion of those shares were nevertheless held by the company “in trust” for Edward’s children. This position was developed around the fact that Mickey had contributed 48% of the total assets to NAI, but himself retained only 1/3 of the stock. He argued that part of the disparity was attributable to the shares that NAI was holding in trust for Edward’s children.

    Edward eventually filed a lawsuit in Massachusetts to determine his ownership of the NAI shares. The parties settled the litigation in 1972 by Edward agreeing that 1/3 of his 100 shares were to be held in trust for his children. The remaining 2/3 of Edward’s shares were redeemed by the company. The IRS later alleged that this transfer to the trust for his children constituted a gift by Edward of a portion of his shares of NAI and sought to collect gift tax.

    The Tax Court determined in Estate of Edward S. Redstone et al. (Tax Court, 10/26/15) that the transfer to the trust in 1972 was not a taxable gift because the transfer was for “full and adequate” consideration in that it was made in settlement of bona fide unliquidated claims. In effect, Edward gave up his claim to 1/3 of his shares in order to lock down his ownership of the other 2/3. There was no intent on his part to benefit his children; he was simply trying to get as much as he could for himself.

    The court’s finding is not surprising or unusual based on the factual record of the case. What is unusual is the timing. How did a transfer that occurred in 1972 find its way into the Tax Court in 2015? Because Edward did not believe he had made a gift in 1972, he never filed a gift tax return for the transfer to the trust. That means that there was no statute of limitations applicable that prevented the IRS from assessing gift taxes for 1972. The most interesting question is how did the IRS find out about the transfer some forty years later? The answer is more litigation. In 2006, Edward’s son Michael, and the trustee of the 1972 trust for Edward’s children, sued Sumner, Edward and NAI, claiming that additional stock should have been transferred to the trusts from Mickey’s grandchildren in 1972.

    The plaintiffs lost their case but the IRS had become aware of the transfers, most likely because someone at the IRS read newspaper accounts of the case. The IRS commenced an audit in 2010 and in 2013 issued a notice of deficiency against Edward’s estate (he died in 2011) for gift taxes from 1972, including a proposed fraud penalty. This forced Edward’s estate to defend a gift tax case based on transfers made more than forty years earlier.

    Edward’s brother Sumner was also assessed a gift tax liability by the IRS. Shortly after Edward reached the settlement regarding his own shares, Sumner also created a trust for his children and transferred 1/3 of his NAI shares to that trust. During the subsequent O’Connor litigation, Sumner testified that unlike Edward, he had “voluntarily” transferred a portion of his shares to the trust for his children.

    The IRS also became aware of Sumner’s transfers from the O’Connor case and proposed a gift tax liability. Sumner’s case also got to the Tax Court in Sumner Redstone v. Commissioner (Tax Court, 12/9/15). This time, the court concluded that the transfer was a gift. The court’s conclusion was largely based on Sumner’s testimony in the O’Connor litigation that his transfers had been voluntary. The court thus treated Mickey and Sumner differently. Mickey was found not to have made a gift because he gave up 1/3 of his shares in a heavily negotiated and contentious settlement in order to obtain the other 2/3 of the NAI shares registered in his name. Sumner was found to have made a gift because his transfer was purely voluntary.

    We are aware of numerous instances where the IRS has become aware of potential taxes owed when the party potentially owing the taxes becomes embroiled in litigation and the facts surrounding the potential liability come out as part of the litigation. It is important to remember that courts are public forums and any time you are in a litigated matter you risk things becoming public that would best have been left private. Similar risks can result simply from news coverage of something you do or a transaction in which you are involved. The IRS very definitely follows the news.