H.A. True Jr. created numerous oil and gas and related companies, all of them family-owned. Each company had a mandatory buy-sell agreement that obligated shareholders to sell the stock back to the other shareholders when they left the corporation’s employment or wanted to dispose of the shares. The price was set at the book value of the shares. When True died on June 4, 1994, his stock was sold to the other shareholders (family members) at the stated book value. The IRS revalued the stock for estate tax purposes. The estate objected and filed with the Tax Court. The court sided with the IRS, and the estate appealed.
Result. For the IRS. In reaching its decision the Tenth Circuit reviewed the four requirements for a valid buy-sell agreement:
The price must be determined by the agreement.
The terms of the agreement must be binding throughout life and death.
The agreement must be legally binding and enforceable.
The agreement must be entered into for bona fide business reasons—not as a testamentary substitute designed to pass assets to beneficiaries at less than full and adequate consideration.
The agreement met the first three requirements. The question was whether it met the fourth.
In evaluating the fourth requirement, it is important to note that it contains two separate tests. First, the buy-sell agreement has to have been entered into for a legitimate business purpose. Second, the agreement cannot be a testamentary device. The estate convinced the Tax Court there was a legitimate business purpose for the agreement, but it did not overcome the presumption of a testamentary device.
Prior cases evaluating testamentary devices have considered the following factors: the health or age of decedent on entering into the agreement; the lack of regular enforcement of the agreement; the exclusion of significant assets from the agreement; the arbitrary manner in which the price was set; the lack of negotiations among the parties; whether the agreement allowed adjustments or revaluation; whether all parties were bound by the agreement; and other evidence of a testamentary plan. Using these factors the court found too many indications of a testamentary device.
The court found the price was set arbitrarily and was not based on an appraisal or in consultation with professionals. There was no revaluation or adjustment to the price in the buy-sell agreement. No negotiations took place. True had arbitrarily set the price and the terms. The use of book value left out significant assets—in this case, the oil reserves. Finally, there was evidence of a testamentary plan as a result of the deletion of the daughter from his will when she sold her stock.
Losing on the testamentary device issue does not automatically mean the value set was incorrect. It means only that the agreement will not be automatically honored. The taxpayer still can prove the agreement provided for full and adequate consideration if the agreed price equals the stock’s fair market value. The estate argued that under Broderick v. Gore (224 F2d 892 (CA-10)), and in several other cases, a buy-sell agreement that was mandatory for all parties was, by definition, fair market value. However, the appellate court said the cases cited by the estate were based on old law before the issuance of new regulations. Consequently, the cases were no longer an enforceable precedent. Examining the buy-sell agreement based on the evidence of actual value, the court concluded the price was not the value of the stock.
This case provides an excellent review of the qualification to use a buy-sell agreement to set values for gift and estate tax purposes. It would be relevant to other businesses that have developed intangibles through R&D since these would not be recorded on the books. The court, by rejecting precedent, made it more important that these agreements meet all the requirements and not just the one involving enforceability.
Estate of H.A. True, Jr. v. Commissioner, 2004 US LEXIS 24844 (CA-10).
Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.