Finfrock v. United States of America
Filing
17
OPINION entered by Judge Sue E. Myerscough on 03/20/2012. SEE WRITTEN OPINION. Plaintiff's Motion for Summary Judgment (d/e 10) and Defendant's Motion for Summary Judgment (d/e 11) are both TAKEN UNDER ADVISEMENT. Defendant shall, by Mar ch 29, 2012, advise the Court whether it is abandoning its alternative argument in support of summary judgment and, if not, whether additional briefing is necessary. The final pretrial conference scheduled for April 30, 2012 at 3:00 p.m. and the bench trial scheduled for May 1, 2012 are VACATED. (DM, ilcd)
E-FILED
Tuesday, 20 March, 2012 02:22:27 PM
Clerk, U.S. District Court, ILCD
IN THE UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF ILLINOIS
SPRINGFIELD DIVISION
CAROLYN FINFROCK, as Executor of the )
Estate of Doris E. Finfrock-Ware,
)
)
Plaintiff,
)
)
v.
)
)
UNITED STATES OF AMERICA,
)
)
Defendant.
)
No. 11-3052
OPINION
SUE E. MYERSCOUGH, U.S. District Judge.
This cause is before the Court on the parties’ cross-motions for
summary judgment. See Plaintiff’s Motion for Summary Judgment (d/e
10); Defendant’s Motion for Summary Judgment (d/e 11). The sole issue
is whether Treasury Regulation 20.2032A-8 (a)(2) (26 C.F.R. §
20.2032A-8 (a)(2)) is a valid regulation. For the reasons that follow, this
Court finds that the regulation is invalid. Because additional issues
remain to be determined, however, the Motions for Summary Judgment
are taken under advisement.
I. FACTUAL BACKGROUND
The parties have stipulated to the following facts
Plaintiff is the executor of the estate of her deceased mother-in-law,
Doris Finfrock-Ware (the decedent), who previously resided in this
District. The decedent died on January 3, 2008.
At the time of her death, the decedent owned 61.05% of the issued
and outstanding stock in the farm corporation Finfrock Farms, Inc.
(Finfrock Farms). Finfrock Farms was a closely-held business pursuant to
the Treasury Department regulations.
At the time of decedent’s death, and for at least 8 years prior to her
death, Finfrock Farms owned the following items of real property: Item 1
(40 acres of real property); Item 2 (122.5 acres of real property); Item 3
(377.21 acres of real property); and Item 4 (165 acres of real property).
There was no formal agreement describing who would operate the farm
on behalf of the corporation. However, for the entire 8 years preceding
the decedent’s death, her son James Finfrock actively farmed Items 1
through 4.
Page 2 of 21
On the decedent’s death, Items 1 through 4 passed indirectly to
qualified heirs as defined in 26 U.S.C. § 2032A(e) through a change in
ownership of Finfrock Farms. The decedent estate’s Internal Revenue
Service (IRS) Form 706, United States Estate (and Generation-Skipping
Transfer) Tax Return (“Form 706”), was filed on October 2, 2008.
In Schedule A of the estate’s Form 706, the estate listed decedent’s
share of Finfrock Farm’s interest in Items 1 through 4, which Plaintiff
alleges constituted “qualified real property” as that term is used in §
2032A. The estate’s “adjusted value of the gross estate,” as that term is
used in 26 U.S.C. § 2032A(b)(1)(A) and (B), was $2,608,848.00. The
estate’s “adjusted value of real property,” as that term is used in 26
U.S.C. § 2032A(b)(1)(B), which consists of the estate’s interest in Items
1 through 4 listed in Schedule A of the Form 706, was $1,775,000.00,
representing approximately 68% of the adjusted value of the gross estate.
The estate made a regular election to specially value its share of
Finfrock Farm’s interest in Item 4. The estate valued Items 1 through 3
using the usual valuation method. The special use valuation of Item 4
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was $227,233.00. The adjusted value of Item 4, $402,930.00,
represents approximately 15% of the adjusted value of the gross estate.
The estate elected to value only the farmland referenced above as Item 4
pursuant to 26 U.S.C. § 2032A because Plaintiff wished to continue
operating Item 4 as a farm, whereas other members of her family opted
not to continue farming Items 1through 3 and sold them to unrelated
third parties shortly after the decedent’s death.
The IRS examined the Form 706 and determined that the estate's
election to value only part of the qualifying real property did not meet
the requirements of applicable federal regulation 26 C.F.R. § 20.2032A-8
(“Treasury Regulation § 20.2032A-8”). Under Treasury Regulation §
20.2032A-8, not only must the adjusted value of all of the estate’s
qualifying real property exceed the 25% threshold as provided in 26
U.S.C. § 2032A(b)(1)(B), but the value of the real property for which the
executor makes the election also must exceed such threshold. As
indicated above, because the estate’s election only included its interest in
Item 4, the adjusted value of which was only 15% of the adjusted value
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of the gross estate, the estate did not meet this threshold. Accordingly,
Defendant “increased the returned value of Item 4 on Schedule A of the
706 return from $227,233.00" (its special use value) to $402,930.00 (its
agreed market value) and assessed an additional tax on account of this
increase. Statement of Undisputed Fact No. 13.
On behalf of the estate, Plaintiff timely filed a claim for refund and
paid the additionally assessed tax. By letter dated February 7, 2011,
Defendant denied the estate’s claim.
On February 23, 2011, Plaintiff filed this lawsuit on behalf of the
estate. Plaintiff contends that the estate should be entitled to elect a
special use valuation for its interest in Item 4 notwithstanding Treasury
Regulation § 20.2032A-8 because the regulation is invalid.
II. JURISDICTION AND VENUE
This Court has jurisdiction pursuant to 28 U.S.C. § 1346(a)(1)
(providing that “[t]he district courts shall have original jurisdiction,
concurrent with the United States Court of Federal Claims, of[] . . . any
civil action against the United States for the recovery of any internal
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revenue tax alleged to have been erroneously or illegally assessed or
collected”). Venue is proper in this District because Plaintiff resides in
Waynesville, Illinois, which is located in DeWitt County. See 28 U.S.C.
§ 1402(a)(1) (providing that a civil action against the United States
under § 1346(a) may, with certain exceptions not applicable here, be
prosecuted only “in the judicial district where the plaintiff resides”);
Complaint for Tax Refund, ¶ 4 (asserting Plaintiff is an individual
residing in Waynesville, Illinois).
III. LEGAL STANDARD
The parties have filed cross-motions for summary judgment
pursuant to Rule 56 of the Federal Rules of Civil Procedure. A court
may grant summary judgment only if the “pleadings, the discovery, and
discovery materials on file, and any affidavits show that there is no
genuine issue as to any material fact and that the moving party is entitled
to judgment as a matter of law.” Fed. R. Civ. P. 56(c); see also, Celotex
Corp. v. Catrett, 477 U.S. 317, 322 (1986). Here, the parties agree that
the material facts are not in dispute and that the case turns on a question
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of law. Therefore, the case may be properly resolved on a motion for
summary judgment. See, e.g., Gallenberg Equipment, Inc. v. Agromac
Intern., Inc., 10 F. Supp. 2d 1050, 1052 (E.D. Wis. 1998).
IV. ANALYSIS
The purpose of § 2032A, which was enacted as part of the Tax
Reform Act of 1976, was “to encourage the continued operation of family
farms and other small family businesses by permitting real property used
for the farm or business to be valued upon its present use, rather than
upon its highest and best use.” Schuneman v. United States, 783 F.2d
694, 697 (7th Cir. 1986). Specifically, Ҥ 2032A relieves taxpayers from
having to sell an eligible family farm or business when the income from
its present use is insufficient to pay the tax calculated upon its highest
and best use.” Id.
To qualify for the special use valuation, several conditions must be
met. One of those conditions is that “25 percent or more of the adjusted
value of the gross estate consists of the adjusted value of real property
which meets the requirements of subparagraphs (A)(ii) and (C).” 26
Page 7 of 21
U.S.C. § 2032A(b)(1)(B). The parties agree that Items 1 through 4
represented approximately 68% of the adjusted value of the gross estate.
The Treasury Regulations, however, provide that while an estate
need not elect special use valuation with respect to all of the qualifying
property, the property actually elected for the special use valuation must
constitute at least 25% of the adjusted value of the gross estate. See 26
C.F.R. § 20.2032A-8(a)(2) (“An election under section 2032A need not
include all real property included in an estate which is eligible for special
use valuation, but sufficient property to satisfy the threshold
requirements of section 2032A(b)(1)(B) must be specially valued under
the election”); see also Miller v. United States, 680 F. Supp. 1269, 1270
n. 1 (C.D. Ill. 1988) (noting the interpretation of the regulation is that
the election must be made on property valued at 25% or more of the
adjusted value of the gross estate). Defendant argues that this regulation
is valid and, because the property elected for special use valuation (Item
4) constituted only 15% of the adjusted value of the gross estate, Plaintiff
is not entitled to the refund. Plaintiff argues that the regulation is invalid
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and in conflict with the statute.
This is not the first time the issue has come before a judge in this
district. In Miller v. United States, 680 F.Supp. 1269, the district court
found Treasury Regulation § 20.2032A-8(a)(2) invalid by using the test
that preceded the test articulated by the United States Supreme Court in
Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467
U.S. 837 (1984). The Miller court found that the Treasury Regulation
was an interpretive regulation, promulgated under the general rulemaking power of the Code, and represented an invalid exercise of that
power. Miller, 680 F. Supp. at 1273-74. The court concluded that
Treasury Regulation § 20.2032A-8(a)(2) added a requirement not found
in the underlying statute that was inconsistent with the statute. Id.
While the parties dispute the persuasive authority of Miller, the
parties agree that the test articulated by the United States Supreme
Court in Chevron is the appropriate test to apply when reviewing the
challenged Treasury Regulation. See Mayo Found. for Med. Educ. &
Research, 131 S. Ct. 704, 713 (2011) (applying the Chevron test to
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review of a Treasury Department regulation, noting “[t]he principles
underlying our decision in Chevron apply with full force in the tax
context”). Under the Chevron test, a court, when reviewing an agency’s
interpretation of a statute it administers, first determines “whether
Congress has directly spoken to the precise question at issue.” Chevron,
467 U.S. at 842; see also Emergency Servs. Billing Corp. v. Allstate Ins.
Co., 668 F.3d 459, 465 (7th Cir. 2012) (identifying the two-step
Chevron test). If the intent of Congress is clear, both the court and the
agency “must give effect to the unambiguously expressed intent of
Congress.” Chevron, 467 U.S. at 843. That is, “[i]f the plain meaning of
the text either supports or opposes the regulation, then we stop our
analysis and either strike or validate the regulation.” Bankers Life &
Casualty Co. v. United States, 142 F.3d 973, 982 (7th Cir. 1998).
If, however, “the statute is silent or ambiguous with respect to the
specific issue, the question for the court is whether the agency’s answer is
based on a permissible construction of the statute.” Chevron, 467 U.S.
at 843 (noting that Congress may explicitly or implicitly leave a gap for
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the agency to fill); see also Mayo, 131 S. Ct. at 714 (identifying step two
of the Chevron test as a determination of whether the rule is a
“reasonable interpretation” of the statute). In the Seventh Circuit, the
legislative history and other appropriate factors are generally considered
during step two of the Chevron test. Emergency Servs. Billing Corp., 668
F.3d at 466.
A.
Treasury Regulation § 20.2032A-8(a)(2) Is Invalid Under the
Chevron Analysis
In this case, Plaintiff only challenges step one of the Chevron
analysis. That is, Plaintiff argues the statute is clear and unambiguous
that the 25% or more requirement only applies to qualify an estate for
the special election but does not require that the executor elect to apply
the special use valuation to property that constitutes 25% or more of the
adjusted gross estate. Plaintiff admits that the Treasury Regulation
20.2032A-8(a)(2) would meet step two of the Chevron test but asserts
that this Court need not reach step two. See Plaintiff’s Combined
Response to Defendant’s Motion for Summary Judgment and Reply in
Support of her Own Motion for Summary Judgment (d/e 12), p. 9
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§
(stating that “we are not going to waste this Court’s time arguing that
.
. . [the regulation] would fail under Chevron Step 2" because the
“regulation is not outrageous, or arbitrary and capricious”).
In contrast, Defendant argues the statute is “silent as to how much
of the qualified real property included in the decedent’s gross estate must
be subject to the special use valuation election.” Defendant’s CrossMotion for Summary Judgment and Response to Plaintiff’s Motion for
Summary Judgment (d/e 11), p. 3. Defendant asserts the Secretary of
the Treasury clarified this ambiguity created by silence by promulgating
Treasury Regulation § 20.2032A-8(a)(2). This Court agrees with
Plaintiff.
Under step one of the Chevron test, this Court first looks to the
language of the statute. Khan v. United States, 548 F.3d 549, 554 (7th
Cir. 2008). The statute provides that if a decedent was a resident or
citizen of the United States, the executor elects § 2032A, and the
executor “files the agreement referred to in subsection (d)(2),”1 then
Subsection (d)(2) provides that “[t]he agreement referred to in this
paragraph is a written agreement signed by each person in being who has an interest
1
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“qualified real property” may be valued at its current use as opposed to
its best use. See 26 U.S.C. § 2032A(a)(1); see also LeFever v. Comm’r of
Internal Revenue, 100 F.3d 778, 782 (10th Cir. 1996) (noting that each
person having an interest in the property must sign and file a personal
liability agreement under § 2032A(d)(2)). The statute defines “qualified
real property” as follows:
(b) Qualified real property.-(1) In general.--For purposes of this section, the
term “qualified real property” means real property
located in the United States which was acquired
from or passed from the decedent to a qualified
heir of the decedent and which, on the date of the
decedent's death, was being used for a qualified
use by the decedent or a member of the decedent's
family, but only if–
(A) 50 percent or more of the adjusted
(whether or not in possession) in any property designated in such agreement
consenting to the application of subsection (c) with respect to such property.” 26
U.S.C. § 2032A(d)(2). Subsection (c) provides that if the qualified real property
ceases to be used for the qualified purpose within 10 years after the decedent’s death,
an additional estate tax will be imposed. 26 U.S.C. § 2032A(c). See also Estate of
Gavin v. United States, 113 F.3d 802, 806 (8th Cir. 1997) (noting that “Congress
included § 2032A(c) ‘to foreclose abuse of the privilege by taxpayers who would
engage in family farming only long enough to reap the estate tax benefits and then
convert the property to a more lucrative commercial use’” (quoting Williamson v.
Comm’r, 974 F.2d 1525, 1527 (9th Cir. 1992))).
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value of the gross estate consists of the
adjusted value of real or personal
property which-(i) on the date of the
decedent's death, was being
used for a qualified use by
the decedent or a member
of the decedent's family,
and
(ii) was acquired from or
passed from the decedent to
a qualified heir of the
decedent.
(B) 25 percent or more of the adjusted
value of the gross estate consists of the
adjusted value of real property which
meets the requirements of
subparagraphs (A)(ii) and (C),
(C) during the 8-year period ending on
the date of the decedent's death there
have been periods aggregating 5 years
or more during which–
(i) such real property was
owned by the decedent or a
member of the decedent's
family and used for a
qualified use by the
decedent or a member of
the decedent's family, and
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(ii) there was material
participation by the
decedent or a member of
the decedent's family in the
operation of the farm or
other business, and
(D) such real property is designated in
the agreement referred to in subsection
(d)(2).
26 U.S.C.A. § 2032A (emphasis added).
Therefore, under the plain language of the statute, to meet the
definition of “qualified real property,” 25% or more of the adjusted value
of the gross estate must consist of real property that (1) “was acquired
from or passed from the decedent to a qualified heir of the decedent”
(26 U.S.C. § 2032A(b)(1)(A)(ii)); and (2) has been used for a qualified
use for 5 of the 8 years preceding the decedent’s death and for which
there was material participation by the decedent or a member of the
decedent’s family in the operation of the farm (26 U.S.C. §
2032A(b)(1)(C)). Subparagraph (D) further defines “qualified real
property” as “such real property” that is designated in the agreement
required by subsection (d)(2). 26 U.S.C. § 2032A(b)(1)(D).
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Notably, the statute does not require that real property constituting
25% or more of the adjusted value of the gross estate be “designated in
an agreement referred to in subsection (d)(2).” 26 U.S.C. §
2032A(b)(1)(D). The 25% or more requirement is a means to limit the
benefit of the special use valuation to family farms and family businesses.
Nonetheless, under the plain language of the statute, once the estate
meets the thresholds identified in subsections (1)(A), (1)(B), and (1)(C),
the only other requirement to qualify as “qualified real property” is to
designate the property in the required agreement. Congress did not
require that the designation be of all or a certain percentage of the real
property in the estate that meets the requirements of 1(A), 1(B), and
1(C). See, e.g., Miller, 680 F. Supp. at 1273 (finding “[t]he language of
Code § 2032A(b)(1)(B) . . . cannot be said to be ambiguous with respect
to the 25% requirement which the regulation imposes”).
This Court finds that § 2032A(b) is neither silent nor ambiguous
on the precise issue – whether an executor can elect for special valuation
property that constitutes less than 25% of the gross value of the adjusted
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value of the gross estate. The statute unambiguously provides that an
executor can do so.
Having found the statute unambiguous, the Court next determines
if the plain meaning of the statute supports or opposes Treasury
Regulation § 20.2032A-8(a)(2). See Bankers Life & Casualty Co., 142
F.3d at 982 (explaining step one of the Chevron test). Here, the
regulation imposes an additional requirement that the property
designated by the agreement referenced in § 2032A(b)(1)(D) and (d)(2)
for special use valuation must constitute at least 25% of the adjusted
value of the gross estate. This additional requirement is contrary to the
plain language of the statute. See, e.g., Miller, 680 F. Supp. at 1273
(finding that “the regulation clearly imposes an additional, substantive
requirement not authorized by the statute”). The regulation neither
clarifies an ambiguity in the statute, because the statute contains no
ambiguity, nor fills any gap, as there is no gap to fill. Therefore, Treasury
Regulation § 20.2032A-8(a)(2) is invalid.
Because this Court finds that the statute is unambiguous and that
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Treasury Regulation § 20.2032A-8(a)(2) conflicts with the statute, this
Court need not proceed to step two of the Chevron test or address
Defendant’s arguments with regard to step two of the Chevron test.
B.
The Case Is Not Resolved, However, Because the Parties Have
Raised Two Additional Matters
Two additional matters must be addressed. First, Defendant, in its
Motion for Summary Judgment, argued for the first time that Plaintiff’s
special use valuation election was invalid because there was no formal
arrangement calling for material participation by the decedent owner or a
family member. See 26 C.F.R. § 20.2032A-3(f) (for indirectly owned
property, “there must be an arrangement calling for material participation
in the business by the decedent owner or a family member . . . [E]ven
full-time involvement must be pursuant to an arrangement between the
entity and the decedent or family member specifying the services to be
performed”). In this case, the parties stipulated that although “[t]here
was no formal agreement describing who would operate the farm on
behalf of the corporation,” the decedent’s son, James Finfrock, actively
farmed Items 1 through 4 for the entire 8 years preceding the decedent’s
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death. See Statement of Undisputed Fact No. 5.
In response, Plaintiff, while not contesting Defendant’s ability to
raise this argument for the first time, argues she agreed to the Stipulation
as written because there was no written contract between Finfrock Farms
and James Finfrock. Plaintiff asserts, however, that there was an
“arrangement” as that term is used in 26 C.F.R. § 20.2032A-3(f)
(requiring “an arrangement calling for material participation”). In
support thereof, Plaintiff submitted James’ Declaration indicating that he
served as chief operating officer for the corporation during all eight years
at issue and engaged in no employment other than managing and
operating the farms.
In its Reply, Defendant concedes that an oral agreement might
satisfy the material participation requirement of the regulation but asserts
that the United States was not previously informed of such oral
agreement. Defendant asserts that it has requested additional
documentation from Plaintiff that might allow Defendant to abandon
this argument. Defendant also notes that the Court need not reach the
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issue if the Court rules in favor of Defendant. Because this Court has
ruled in favor of Plaintiff, this remaining issue needs to be resolved.
Therefore, Defendant shall advise the Court, by March 29, 2012,
whether it is abandoning this argument and, if not, whether additional
briefing is necessary. If additional briefing is necessary, this Court will
set a briefing schedule.
Second, the parties stipulated that, in the event the Court found in
favor of Plaintiff, the parties would attempt to collaborate in the
submission of a proposed final judgment which would include a
calculation of the proper amount that should be refunded. If the parties
could not reach an agreement, they agreed to file supplemental briefs on
that issue. Obviously, this issue cannot be addressed until Defendant has
informed the Court whether it is abandoning its argument regarding the
existence of an arrangement calling for material participation.
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Therefore, this issue will be addressed after Defendant advises the Court
on March 29, 2012.
V. CONCLUSION
For the reasons stated, Plaintiff’s Motion for Summary Judgment
(d/e 10) and Defendant’s Motion for Summary Judgment (d/e 11) are
both TAKEN UNDER ADVISEMENT. Defendant shall, by March 29,
2012, advise the Court whether it is abandoning its alternative argument
in support of summary judgment and, if not, whether additional briefing
is necessary. The final pretrial conference scheduled for April 30, 2012
at 3:00 p.m. and the bench trial scheduled for May 1, 2012 are
VACATED.
ENTER: March 20, 2012
FOR THE COURT:
s/ Sue E. Myerscough
SUE E. MYERSCOUGH
UNITED STATE DISTRICT JUDGE
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