COURT CASE UPDATE

1. COURT CASE UPDATE 30th Annual Workshop for Managing Closely Held Business Interests in Trusts and Estates September 27 – 30, 2005 Presented by Jeremy WeirMPI Regional Director77 Franklin Street, 5th FloorBoston, MA 02110www.mpival.com 617-482-6462 ▪ 617-482-2515 FaxJWeir@mpival.com

2. Introduction • Issues • 2036 (a) • Built in Capital Gains • Minority Discounts • Lack of Marketability

3. Court Cases • Family Owned Entities • Operating Companies • U.S Court of Appeals Decisions

4. 2036 (a) 1 and (2) Sec. 2036. TRANSFERS WITH RETAINED LIFE ESTATE General Rule. – The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death— (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

5. Estate of Wayne C. Bongard v. Commissioner, 124 T.C. No. 8. Filed March 15, 2005. Background • WCB incorporated Empak, Inc. in 1980. Company manufactured computer and semi-conductor storage packages. • In 1986, WCB set up Irrevocable Trust to hold Empak stock. • January 30, 1996, Board and advisors to WCB approve set up of holding company (WCB Holdings, LLC) in preparation for seeking liquidity event, driven by business needs for capital and remaining competitive. Class A and Class B units make up membership. Each class has governance and financial units. Only Class A has voting rights. LLC is funded with Empak stock from Bongard and Irrevocable Trust. • December 28, 1996, WCB and Trustee exchange shares of Empak for Class A and Class B units. • December 29, 1996, WCB sets up Bongard Family Limited Partnership (BFLP).

6. Estate of Wayne C. Bongard v. Commissioner Background – P. 2 • December 10, 1997, WCB, as part of post-nuptial agreement, gifts 7.72% BFLP interest to wife, under marital deduction rules. • November 16, 1998, WCB dies on a hunting trip in Austria at age 58. • February 15, 2000, Estate timely files 706 Tax Return, using alternate valuation date.

7. Estate of Wayne C. Bongard v. Commissioner Background – P. 3 Summary of holdings.

8. Estate of Wayne C. Bongard v. Commissioner Background – P. 4

9. Estate of Wayne C. Bongard v. Commissioner Background – P. 5 • BFLP Class A Units valued at $4,193,000. Class B Units valued at $41,329,838. • IRS claimed Section 2036 (a) applied at both the WCB Holdings and BFLP levels and valued the underlying Empak, Inc. shares at $141,621,482, creating a deficiency of almost $53 million. • Prior to trial, Empak, Inc. stock stipulated to be $32.24 before any discounts. IRS amended answer to increase deficiency claiming stock could be worth additional $20 million. • Both sides make Burden of Proof Claims. • This case is reviewed by the full Tax Court.

10. Estate of Wayne C. Bongard v. Commissioner • Tax Court Judge Goeke findings: • WCB Holdings, LLC was formed with a valid business purpose and decedent received full and adequate consideration. Transfers of Units to Children’s and Grandchildren’s and QTIP trusts protected. • BFLP fails valid business purpose and bona fide sale tests. Judge rules that there was an implied agreement to allow the decedent to control the Class A units in BFLP. • With pre-discounted value stipulated at $32.24 per share, discounts applied were also stipulated: • Minority Interest discount of 13.0% for Class A and Class B. • Additional 5% discount applied to Class B for lack of voting rights. • LOM discount 17.5% applied to Class And Class B units. • To understand the complexities of 2036 (a) and (b), this case is a must read case. There are many dissents and concurrences.

11. Estate of Charles Porter Schutt v. Commissioner, T.C. Memo. 2005-126. Filed May 26, 2005. Background • Mr. and Mrs. Schutt had four children and 14 grandchildren. Mrs. Schutt (a duPont family member) owned significant wealth through family trusts set up for her benefit. • Trusts contained shares of duPont stock and Exxon Corporation. • Mrs. Schutt died in 1989. Death of daughter in 1993 resulted in distribution of family trust. • Schutts concerned with keeping buy and hold investment strategy alive as assets move from one generation to the next. • In 1998, after two years of work, Delaware business trusts were established to hold stock previously held by trusts, one for duPont stock, one for Exxon stock.

12. Estate of Charles Porter Schutt v. Commissioner Background – P. 2 • Schutt I held $68 million in duPont stock contributed by 8 different trusts, including Mr. Schutt’s trust (45.236% interest). • Schutt II held $24 million in Exxon stock contributed by 6 different trusts, including Mr. Schutt’s trust (47.336% interest). • Outside of Schutt I & II, Mr. Schutt owned assets of $30 million. • Schutt I & II terminated in 2048, unless extended by Trustee and majority in interest in trusts. • Amendments required 66% approval for change. • Prior to decedent’s death, trusts had not sold or bought any other asset.

13. Estate of Charles Porter Schutt v. Commissioner Background – P. 3 • Mr. Schutt died April 21, 1999, approximately one year after Business Trusts were formed. • Alternate valuation date used, with value of Schutt I (duPont stock) at $15.8 million and $7.2 million for Schutt II (Exxon stock). • Original discounts for minority interest and LOM aggregated 53.6%. • IRS filed notice of deficiency based on level of discounts. • In response to answer by estate, filed increased deficiency asserting inclusion of value of assets under 2036 (a) and 2038. • At trial, IRS and Estate stipulated that a finding in favor of estate would result in values based on overall discount of 32.5%.

14. Estate of Charles Porter Schutt v. Commissioner Tax Court Judge Wherry • Because IRS did not raise 2036 (a) or 2038 in original notice, burden of proof shifted from estate to IRS. • Begins with focus on bona fide sale test: • Based on 3rd Circuit, to which this case would be appealed, transfer must be made in “good faith”. This is equivalent to “significant non-tax reason” for the transfer. • Will be given “heightened scrutiny” because transfer is intrafamily. • “(L)egitimate non-tax reasons often inextricably interwoven with testamentary objectives.” • Must be aware of potential divergence between decedent’s motives and concerns of advisers.

15. Estate of Charles Porter Schutt v. Commissioner Judge Wherry Decision • Preponderance of evidence points to decedent’s primary motive being to perpetuate his buy-and-hold investment philosophy. • Estate planning and valuation discounts show up very little in record; • Denial of gifts to grandchildren who had previously sold stock distributed to them is example of decedent’s concern; • Participation of trust managed by WTC is evidence of concern beyond decedent’s own wealth; • WTC’s insistence on beneficiary sign-off on plan that would likely tie up assets of trusts beyond termination of trust; • Lack of active management of portfolio, usually an indication of testamentary device, in this case confirms intent of buy/hold philosophy.

16. Estate of Charles Porter Schutt v. Commissioner Judge Wherry Decision • “Adequate and full consideration” test was met. • Property contributed in timely manner; • Properly credited to capital accounts; • Decedent’s revocable trust received no greater rights than other participants (Ability to control assets in trust lost with exchange for interests in Schutt I & II.) • No commingling with personal assets. • Decedent not dependent on distributions, had adequate other assets for support. • Decedent not on both sides of transaction.

17. Estate of Virginia A. Bigelow v. Commissioner, T.C.Memo. 2005-65. Filed March 30, 2005. Background • VAB funded revocable trust in 1991 with 98.28% undivided interest in her personal residence. VAB and son were Trustees. • In fall of 1992, the Trust listed its property for sale. In early 1993, Trust sold its residence in an exchange/leaseback of another property. Trust borrowed funds against new property to pay off loans collateralized by former property. • In 1994, Trustees and children established an FLP funded by transfer of residence in trust. Loan against property was not transferred. • Also, in 1994, VAB suffered a stroke and moved into an assisted-living facility. Her son had a durable power of attorney. • VAB died August 8, 1997, at age 88. • By 12/31/1998, FLP terminated, final distributions made, dissolution papers recorded.

18. Estate of Virginia A. Bigelow v. Commissioner Tax Court conclusions • Fails bona fide sale test – transferred property but not associated liabilities. • Transfer was not in good faith. Impoverished donor. • Retained rights/interest/enjoyment. • Used FLP income to pay donor’s loan obligations, • Income distributed prior to death went only to VAB, • Present economic benefit equals “enjoyment,” • FLP property continued to secure VAB’s debt. • Did not respect partnership formalities • Accounts not properly maintained, • K-1s were filed with errors.

19. Estate of Virginia A. Bigelow v. Commissioner Tax Court Conclusions, P – 2 • No non-tax benefit to VAB • VAB Trust was GP and therefore no added protection of trust. (Compare with Kimbell where LLC owned by trust was GP.) • No continuity of management provided. Termination of Trust triggered dissolution of FLP. • More efficient gift device is seen as spurious.

20. Estate of Timothy J. Tehan v. Commissioner, T.C.Memo. 2005-128. Filed May 31, 2005. Background • Decedent had eight children. • 1990 – purchased condominium, Chevy Chase, MD, for $240,000. • 1/25/1992 – executed Irrevocable Trust funded with $100 cash and Life Insurance policy. • 11/5/1997 – executed agreement with children covering use of condo while TJT is alive: • No rent; TJT responsible for mortgage on unit and all other costs; • If TJT leaves, costs are split, but property must be sold and proceeds divided according to fractional ownership; • Transfer restrictions with right of first refusal.

21. Estate of Timothy J. Tehan v. Commissioner Background – P. 2 • 4.5% fractional interest gifts made 11/1997 (36% total); • 1/2/1998, same level of gifts made; (36% total); • 3/25/1999 – 3.5% gifts made (28% total). • TJT dies May 17, 1999; his will leaves everything equally to children. • Children sell condo. • 706 timely filed, reporting no real estate, no lifetime transfers. • IRS sends notice of deficiency claiming total value of real estate under 2036 (a).

22. Estate of Timothy J. Tehan v. Commissioner Tax Court Judge Chiechi • Express agreement to enjoy covered in 11/5/97 agreement; • Retained a life estate in property; • 11/5/97 agreement not equivalent to lease agreement; • Free use and occupancy; • Paid expenses; • No permission to use required; • Children never used; • No child ever attempted to sell interest while father was alive.

23. Estates of Edna and Austin Korby, T.C.Memo. 2005-102, T.C.Memo. 2005-103. Filed May 10, 2005. Background • Edna and Austin Korby had four children. • 1993 – Edna diagnosed with severe Alzheimer’s dementia. She dies after long term in nursing home on July 3, 1998. • Prior to 1993, Austin suffered stroke, diagnosed with Type II diabetes, hypertension, cardiac arrhythmias. He dies December 2, 1998. • 1993 – Edna and Austin set up living trust, funded over two years with money market account, house, vacant lot, checking account, savings account, household furnishings, 1% interest in Crane Properties LP, 2% GP interest in Korby Properties LP (KPLP), and monthly social security checks. • 3/26/1994 –KPLP formed as Minnesota LP. Trust was GP from beginning until 1999.

24. Estates of Edna and Austin Korby Background – P. 2 • KPLP not funded until Spring 1995: • Money market account from trust => 2% GP interest. • Stocks worth $1,330,442 • State and Muni bonds worth $449,378 =>98% LP to Edna & Austin • US Savings bonds worth $71,378 • After funding of KPLP, Korbys’ had no bank accounts in own name. • 1995 – Korbys make joint gifts of 24.5% LP interests to irrevocable trusts for each son. • Gift tax returns filed valuing gifts at $521,870, using 43.61% discount for lack of control and lack of liquidity. • August 1995, Austin buys annuity for $140,000 payable to himself with KPLP as owner.

25. Estates of Edna and Austin Korby Background – P. 3 • KPLP and trust pay living expenses of Korbys from 1995 through 1998. • KPLP payments to Trust called management fees. • 706 for Edna is not timely filed, nor extension applied for by estate. • IRS sends notice of deficiency claiming inclusion of all assets of KPLP and living trust under section 2036 (a).

26. Estates of Edna and Austin Korby Tax Court Review – Judge Goeke • Estate has burden of proof. • Finds implied agreement for enjoyment of income: • Poor health of Korbys; • Essentially no assets for support after KPLP; • Payment of management fees not allocated; • Unequal distributions: 2% paid $120,000; 98% paid $12K; • No management contract coupled with no regular payment of fee; • No evidence of management. • Not a Bona Fide sale: • In family context, need to demonstrate non-tax reason for LP; and reason must be actual motivation, not theoretical justification;

27. Estates of Edna and Austin Korby Tax Court Review – Judge Goeke – P. 2 • Finds sons not involved in planning even though they owned interests and were signatories to LP; • Payment of income/expense to Korbys weighs against bona fide sale.

28. Estate of Helen M. Noble v. Commissioner, T.C. Memo. 2005-2. Filed January 6, 2005. Background • Case involves valuation of 116 shares, 11.6% minority interest, in Glenwood State Bank of Nebraska. • Valuation Date: Sept. 2, 1996. • Decedent only other stockholder of Bank, balance owned by holding company controlled by unrelated party. • 706 Value, submitted July 1998, provided value of $903,988. • IRS valued shares at $1.1 million. • Tax Court valued shares at $1,067,000. • Estate had sold shares to other stockholder October 24, 1997 for $1.1 million.

29. Estate of Helen M. Noble v. Commissioner – P. 2 Valuation approaches • Estate on 706 used Book Value per share, less 45% minority interest discount. Value done by CPA. • At trial, estate used three experts and presented value of $841,000 derived by Chris Mercer, using five methods, relying on two, using QMDM to arrive at LOM of 43%. • IRS appraiser, William C. Herber of Shenehon Company used: • Book Value • DCF • Guideline – public and private • 15% minority interest • 30% Lack of Marketability (LOM) • Judge Laro began with actual transaction value, less present value using 3% inflation rate.

30. Estate of Helen M. Noble v. Commissioner – P. 3 Tax Court Reasoning • Burden of proof lies with Estate. • Estate rejected offer from buyer at $878,004 in December 1996. • Estate actually sold shares at $1.1 million 13 months after date of death but 10 months before filing tax return. • With only buyer of two smaller prior blocks the same as buyer of Estate’s shares, hypothetical seller would know opportunity to sell at higher price. • Use of subsequent sale, after valuation date, is reasonable, especially when subsequent sale is the same block being valued. • Should adjust subsequent sale for: (a) inflation, (b) changes in relevant industry, (c) business changes, (d) economic change, (e) other relevant data known or knowable. But court only applies inflation factor.

31. Estate of Frazier Jelke III v. Commissioner, T.C.Memo. 2005-131. Filed May 31, 2005. Background • Successful Jelke family C-corporation (“CCC”) operating company assets sold in 1974. CCC invested proceeds and became a personal holding company (“PCH”). • Ownership split between Decedent and irrevocable Jelke family trusts. • Wilmington Trust Company was trustee of trusts owning 77.186%, including Decedent’s 6.44% (3,000 shares) taxable in his estate. • No single trust had controlling interest. • No restrictions on sale of stock. No sales or attempts to sell stock in last ten years. • Decedent died March 4, 1999.

32. Estate of Frazier Jelke III v. Commissioner CCC • Total assets of $190.8 million; $178.9 in equities (92% domestic, 8% International), $11.8 in money market funds. $2.1 million in liabilities. • NAV $188.6 million. • Built-in Capital Gain liability of $51.6 million. • NAV of decedent’s 6.44% interest was $12.2 million. • Value submitted on 706 was $4,588,155.

33. Estate of Frazier Jelke III v. Commissioner Howard, Frazier, Barker, Elliot, Inc. Appraisal

34. Estate of Frazier Jelke III v. Commissioner IRS Appraisal – Mr. Shaked

35. Estate of Frazier Jelke III v. Commissioner Tax Court Judge Gerber

36. Estate of Frazier Jelke III v. Commissioner Judge Gerber’s Opinion • In minority interest fact case, tax liability for capital gain should be calculated on the basis of established history of securities turnover. • Distinguishes between Jelke Estate and Estate of Dunn(T.C.Memo.2002-12 and U.S. Court of Appeals, Fifth Circuit, No. 00-60614). Minority interest v. control level. • Liquidation presumption is not appropriate to this minority interest. • No factual circumstances to support liquidation. • Finds fault with minority discount of both experts: • For estate expert, discount is outside range of guidelines, unsupported; overlooks important aspects of PHC, and is inconsistent with other positions. • IRS expert uses discount below (5%) an average taken from the Journal of Economics (8.61%), lacks detail on guidelines.

37. Estate of Frazier Jelke III v. Commissioner Judge Gerber’s Opinion – P. 2 • Questions whether closed-end fund discount is all minority, or includes some LOM. • Finds fault with both experts’ LOM (35% v. 10%) and chooses 15%. • Estate’s expert use of studies are not sufficiently comparable for reliance. • Agrees with Shaked that PHC performance warrants lower-than-average LOM. • No restrictions on transfers. • Draws distinction between PHC liquidity and liquidity in underlying assets. • Notes that PHC had cash reserve in case of redemption need.

38. Appealed Case Decisions • Albert Strangi v. Commissioner, 5th Cir., No. 03-60992. Filed July 15, 2005. • Prior citations include: • Strangi 1 – 115 T.C. No. 53. Filed November 30, 2000; • Strangi 2 – 293 F 3d 279 (5th Cir. 2002); • Strangi 3 – T.C. Memo. 2003-145. Filed May 20, 2003. • Decision: • Found no reversible error on 2036 (a) by Tax Court; • Distinguishes case from Kimbell.

39. Appealed Case Decisions • Estate of Ida Abraham v. Commissioner, 1st Cir., No. 04-1886. Filed May 25, 2005. • Prior citation: T.C. Memo 2004-39. Filed February 18, 2004. • This a 2036 (a) case appealed by the Estate. • Tax Court decision is affirmed by First Circuit.

40. THANK YOU! MPI CONGRATULATES THE NTCHBA ON CELEBRATING 30 WONDERFUL YEARS IN SERVICE TO THE FAMILY OWNED BUSINESS

41. Services for the Closely Held CommunityFinancial Advisory ▪ Sale of Minority Interests ▪ M&A Advisory Corporate Valuations ▪ Fairness Opinions Representative Assignments The John Bickford Foundation Completed the sale of a minority interest in Transistor Devices, Inc. on behalf of the John Bickford Foundation Transaction Size $4MM A Global Consumer Products Business Completed the sale/merger valuation of an undisclosed consumer products company on behalf of the trustees of the estate of the founder. Major U.S. Bank Fairness Opinion for Closely Held Business Group regarding the potential sale of a block of a micro-cap public company. Completed the sale of Stahl Specialty Company to a unit of ThyssenKrupp. Revenues $115MMTransaction Size not disclosed. Privately Held Convenience Store Company Advising this $120 million revenue company in a sale transaction. Transaction pending. Privately Held Specialty Retailer Advised Board of Directors of this $400 million revenue company regarding strategic alternatives and shareholder liquidity options. Privately Held Manufacturing Company Advised Board of Directors of this $90 million revenue company in the evaluation of strategic alternatives and shareholder liquidity options. Jim Dwyer ▪ Princeton, New Jersey Telephone: 609-924-4200 Fax: 609-924-4573 www.mpisecurities.com www.mpival.com