On Appeal from the United States District Court for the Western District of Pennsylvania, D.C. Civil No. 84-320 E.
Sloviter, Becker and Garth.
This appeal in a tax refund case concerns the correct valuation for federal estate tax purposes of 54,000 shares of stock subject to certain legally binding, nonassignable stock options granted to the children and grandchildren of decedent, Ruth H. Dorn. The district court found that the shares should be included in the gross estate at the option price, as advocated by the executors, and not at the market price of the shares on the date of death, as contended by the government. According, the district court entered judgment for Dorn's executors.
We find it clear from the record that none of the options was granted pursuant to "a bona fide business arrangement." Instead, all were "a device to pass the decedent's shares to the natural objects of [her] bounty for less than an adequate and full consideration in money or money's worth." Treasury Regulation 20.2131-2(h). That regulation controls here and requires that the stock be valued for estate tax purposes at the price at which it traded when Dorn died. We therefore reverse and direct the entry of judgment in favor of the Government.
Pursuant to a pretrial stipulation filed with the district court, the facts material to this case are not in dispute. On July 2, 1973, Ruth H. Dorn granted to her children and grandchildren options on a total of 18,000 shares of Forest Oil Corporation (hereinafter "Forest Oil") common stock, exercisable at any time for ten years from the date of the grant. Under the terms of the options, each child or grandchild -- there were thirty six such people -- could purchase 500 shares of the stock at the price of $20 per share. On December 21, 1973, decedent granted an identical set of options except that, unlike the first set, these contained a declaration that the decedent "intend[ed] to be legally bound [t]hereby."
Finally, on January 10, 1974, decedent granted to her children and grandchildren a third set of options for 36,000 more shares of Forest Oil common stock (so that there were options outstanding on a total of 72,000 shares). Under the third set, each child or grandchild received the option to purchase 1,000 shares of stock for $24 per share with the options exercisable for ten years from the date of grant. Like the second set of options, the third set contained a declaration that the decedent intended to be legally bound thereby. The parties have stipulated that Dorn's intention in granting all three sets of the options was to transfer all appreciation in the optioned stock in excess of the option price as a gift, and what no consideration in money or money's worth was received for the options. However, they have also stipulated that the second and third sets of options granted were legally binding on Dorn under the laws of the Commonwealth of Pennsylvania.*fn1
While the options were exercisable the decedent and her estate retained legal title to sufficient shares of Forest Oil common stock to cover any calls her relatives could have made thereunder. No legal restrictions prevented the option holders from exercising any of their options, nor were there any formal or informal agreements made by the option holders which restricted their right to exercise them. The stock options were granted on the advice of Dorn's estate planning advisers. The advisers believed that the "option technique" could limit the value of the Forest Oil stock that would become subject to federal estate tax in her gross estate. Specifically, it was their hope, and decedent's to remove from her gross estate any appreciation in the stock above the option prices. The option prices were set in such a way that the value of the option would be within Dorn's annual exclusion for gift tax purposes.
Dorn died on July 4, 1980. On that date she owned 72,074 shares of Forest Oil Stock. As the date of her death, none of her children or grandchildren had exercised any of the options.*fn2 Forest Oil common stock was traded over-the-counter from at least 1973 through 1982. The fair market value of the stock on the date of Dorn's death was § 31.4375 per share, based upon the mean between the bid and asked prices in the over-the-counter market on July 3, 1980, and July 7, 1980.
On April 6, 1981, Clayton Dorn and David Dorn, as executors of decedent's estate, filed a federal estate tax return. On that return each share of decedent's Forest Oil common stock was valued at its option price, either $20 or $24 per share. Subsequently the Commissioner determined that the stock should have been valued at the mean between the bid and asked prices on July 3, 1980 and July 7, 1980--$31.4375 per share. He asserted a deficiency of $298,113.37 in estate tax.*fn3 The executors paid the asserted deficiency plus the interest thereon and filed an administrative claim for refund. The claim was not allowed, and the executors filed a suit for refund in the district court on November 16, 1984.
In the district court, the material facts were stipulated, and the case was submitted on cross-motions for summary judgment. The executors argued that the stock should be valued for federal estate tax purposes at its option price. The Government, on the other hand, urged that the stock must be included in the decedent's gross estate at its fair market value, as determined by the market quotations on the applicable valuation date.
The district court sustained each side's position in part. As to the first set of options, covering 18,000 shares, the court agreed with the Government that they were not only unsupported by consideration but also nonbinding, since they lacked any declaration by the decedent that she intended to be bound thereby. The court concluded that such nonbinding options did nothing to depress or elevate the value of the stock, so that the market quotation of $31.4375 controlled the estate tax valuation of the shares covered by those options.*fn4
The district court ruled that the remaining 54,000 shares were includible in the decedent's gross estate at the option price ($20, or $24, as the case might be). The district court based this decision on its conclusion that Dorn did not own all of the property rights evidenced by the 54,000 shares of Forest Oil common stock because, by granting legally binding options, she had irrevocably transferred a portion of those property rights to her children and grandchildren. The court recognized that the decedent had granted those options "as a gift," and that Dorn received no consideration in exchange. Like the executors, however, the district court reasoned that the binding options "divided up" the decedent's "bundle of property rights" in the stock into "two separate property interests," and gave "one of those separate property interests" to the donees, thereby permitting them to capture the benefit of any appreciation in the stock over the option price. App. at 100; appellees' br. at 26-33. In giving away that benefit to the optionees, the court decided, the decedent had made "irrevocable inter vivos gifts" ...