Thursday, June 28, 2018

Redstone Family Saga Writ Large In Favorable Tax Court Decision

This post was originally published on Forbes Oct 31, 2015

The Estate of Edward Redstone, brother of Viacom Chairman Sumner Redstone, received a favorable ruling from the Tax Court in its challenge of an IRS assertion of a gift tax deficiency.  The tax was $737,625 and an assertion of fraud or alternatively negligence and failure to file could have tacked on as much as $553,219, but the stakes were much higher.  Even without the penalties, by my somewhat rough computation, the interest on the tax would have been around $15.5 million.

As Abraham Lincoln said, you have to be careful about quotes cited on the internet but the one attributed to Albert Einstein that compound interest is the most powerful force in the universe, is something he should have said whether he did or not.  Interest on tax deficiencies has been compounding daily since 1982, nearly a decade after the gift tax return that the IRS claims Edward Redstone neglected was due for gifts made in 1972.

Family Business

Sumner Redstone, famously took his father's theater chain National Amusements to another level by investing in companies that produced content, coining the term "Content is king".  The Redstone family saga would probably make some great content.  It has elements of Greek tragedy about it, but there are other Forbes contributors who cover that sort of thing much better than I can.  This particular Tax Court decision relates to one of the elements of the family drama, the buyout of Edward from National Amusements.

The stock ownership of National Amusements was equal among the founding father, Mickey, and the two brothers.  That ownership went back to the company's founding in 1959.  While building the drive-in business Mickey's practice had been to have three corporations for each drive-in - one to own the real estate, one for the theater operation and one for the refreshments.

That sort of thing could save a lot of corporate income tax back in the day - meaning before the Tax Reform Act of 1969 forced corporations with common ownership to share one set of favorable tax attributes such as surtax exemptions or used property investment credit limitations among them.  The complicated structure created difficulties with financing, which is why the holding company was formed.

The various corporations had different ownership percentages.  If the holding company stock had been assigned based on book value in the subsidiaries the ownership would have worked out 47.88% Mickey, 26.49% Sumner and 25.63% Edward.  The stock was issued equally and the three stock certificates, each for 100 shares were kept in the company safe.  When it came to jobs there was a difference between Edward and Sumner.
Mickey gave Sumner, his elder son, the more public and glamorous job of working with movie studios and acquiring new theaters. Edward had principal responsibility for operational and back-office functions. His duties included maintaining existing properties and developing new properties.
Dad Made Him Do It

More drama.

Edward's son Michael has issues, that I would just as soon leave for others to discuss.  Mickey did not think Edward had handled things well, which created family tension.
About this time Edward began to feel marginalized, not only within his extended family, but also within the family business. He became dissatisfied with his role at NAI, with certain business decisions that Mickey and Sumner had made, and with what he regarded as a lack of respect for his views. He began to discuss, in general terms, the possibility that he might leave the family business. This possibility became more concrete when Sumner, without first discussing the matter with Edward, hired Jerry Swedrow to take over Edward's responsibilities for NAI operations. When Edward learned of this he became incensed. In June 1971 he abruptly quit the family business.
At this point the contribution discrepancy back in 1959 came into play.
Mickey and his attorneys also developed an argument that a portion of Edward's stock, though registered in his name, had actually been held since NAI's inception in an “oral trust” for the benefit of Edward's children. This argument built on the fact that Mickey in 1959 had contributed 48% of NAI's capital yet had received only 33.33% of its stock. In effect, Mickey contended that he had gratuitously accorded Edward more stock than he was entitled to, and that, to effectuate Mickey's intent in 1959, the “extra” shares should be regarded as being held in trust for Edward's children. Mickey initially insisted that at least half of Edward's shares were covered by this alleged oral trust.
The parties negotiated for six months in search of a resolution. They explored, without success, various options whereby Edward would remain in the business as an employee or consultant. Edward offered to sell his 100 shares back to NAI, and the parties explored various pricing scenarios under which this might occur. As the family patriarch, however, Mickey had most of the leverage, and he insisted that Edward acknowledge the existence of an oral trust for the benefit of Edward's children. Mickey's insistence on an oral trust was a “line in the sand” and a “deal breaker.”
Litigation commenced, but finally there was a settlement.  Edward was paid $5 million for 66 2/3rds of his 100 shares and agreed that the other 33 1/3rd were held in trust for his kids.  Edward's accountant did not think that a gift tax return was required, because there had been no donative intent.

Who's Gonna Know?

We used to have an expression at Joseph B Cohan and Associates - "old and cold".  The idea was that if something happened long enough ago, it was not going to be questioned.  So you would think that after 40 years the transfer of those shares to a trust would be "ancient and frozen", but apparently not as far as the IRS is concerned.   Edward died late in 2011, so perhaps it was diligence on the part of the estate tax auditor who would have been clued into the "oral trust" story because of messy litigation commenced in 2006 by Michael and trustees for trusts set up for Sumner's children Brent and Shari and Edward's children Michael and Ruth Ann.

Not A Gift

The Tax Court ruled that Edward's transfer of shares to a trust for his children in 1972 was not a gift as it satisfied the three requirements to be a transaction in the "ordinary course of business".  It was "bona fide":
Edward's agreement to release his claim to 33 1/3 shares of NAI stock represented a bona fide settlement of this dispute. Although Edward had a reasonable claim to all 100 shares registered in his name, Mickey had possession of these shares and refused to disgorge them, forcing Edward to commence litigation. The “oral trust” theory on which Mickey relied was evidently a theory in which he passionately believed. And it had some link to historical fact: at NAI's inception, Edward was listed as a registered owner of 33.33% of NAI's shares even though he had contributed only 25.6% of its assets.
It was "arms length":
All the elements of arm's-length bargaining existed here. There was a genuine controversy among Edward, Mickey, and Sumner; they were represented by and acted upon the advice of counsel; they engaged in adversarial negotiations for a protracted period; the compromise they reached was motivated by their desire to avoid the uncertainty and embarrassment of public litigation; and their settlement was incorporated in a judicial decree that terminated the lawsuits.
There was no "donative intent":
Edward's objective throughout the 1971-1972 dispute was to obtain for himself ownership of (or full payment for) the 100 NAI shares originally registered in his name. Mickey floated in late 1971 the concept that Edward had held a portion of these shares since 1959 in trust for his children. If Edward had been motivated by donative intent toward his children, he could have embraced Mickey's concept at once and resolved the dispute without the expense and family disharmony generated by filing two lawsuits. Edward filed these lawsuits because he refused to embrace the “oral trust” theory and wished to obtain possession, in his own name, of all 100 shares
 There May Be More

Sumner also has a Tax Court case in process related to 1972 gift tax.  There was an attempt to get the Tax Court to rule in his favor on a summary basis under the doctrine of laches, but the Tax Court ruled against that.  The IRS is pursuing Sumner for the same amount of gift tax that it was seeking from Edward.  Presumably when Edward transferred the 33 1/3 shares of stock to a trust for Michael and Ruth Ann, Sumner did the same to a trust for Brent and Shari.

I'm thinking that the Government will have an incentive to settle with Sumner, since some, although not all, of the arguments Edward's estate made should work for Sumner.

Other Coverage And Comments

Lew Taishoff  is suspending judgment on Edward's case, but he had done something on the interim decision in Sumner's case.
 On another topic, Peter Reilly, CPA, Forbes’ formidable blogger, asked if I had any comment on Estate of Edward S. Redstone, Deceased, Madeline M. Redstone, Executrix, 145 T. C. 11, filed 10/26/15. ....
Reflecting, it might just be that Edward’s favorable result might bail out Sumner as well, as IRS’s case depends upon various stock transfers being gifts, and Edward beat that one. But I’d need to see more facts before coming to that conclusion. And that’s why I’m reserving comment at this time.
Jack Townsend had a post about the case in a somewhat surprising place, his DOJ Tax Division Alumni Blog - with the title - Tax Division Alumnus in the Tax News.  The alumnus is none other than Sumner who did a stint with DOJ Tax  before joining the family business in 1954.  The stint at DOJ Tax is not even the most intriguing piece of Sumner's biography.  While still an undergraduate at Harvard, he was recruited by the Army to help break Japanese codes.

The Moral? First, there’s no gift to the thief who points a gun at you, and there’s no gift when you transfer shares because you have to.
Perhaps more importantly, gift tax can be assessed forever if you don’t file a gift tax return. If there is any question on whether a gift might have happened, or realistic risk that the IRS will challenge the amount of a gift, it’s wise to file a gift tax return even when it doesn’t appear gift tax is owed. Otherwise the statute of limitations never starts running, and you might be fighting a forty-years war with the tax man.
Joe's advice is sound, although I'm not sure it would have helped Edward, because I believe that zero liability gift tax returns did not start the statute running back in the day.
 Joe was kind enough to check my interest computation by running it through a program which I am too cheap to buy and confirmed that I was within a few thousand dollars.  If you have trouble wrapping your head around a three-quarter million deficiency generating $15.5 million in interest, you can try the following.

The pre-TEFRA simple interest which started at 6% and had gone as high as 20% in 1982 added about 87% to the tab.  The daily compounded rates since 1982 started out high - 16%.  The average rate over the 33 years since then has been about 7.5%.  Using the rule of 72 that will cause you to double not quite 4 times in 33 years.  That won't give you the answer I came up with after a couple of hours on excel or that Joe came up with because he spent maybe $150, I'm too cheap to lay out, but it will be in the general neighborhood.

There was a write-up on .  Taxnotes has something , but you have to remember what I said about how I am a cheapskate. has a fairly lengthy write-up by Dawn S. Markowitz.

My friend Matt Erskine, who has a boutique practice focusing on estate issues and unique assets wrote me:
In my opinion, the tax court is correct. The transfer of stock to the trust for the children is not a gift. The taxpayer met the standards for the exemption to the gift tax as in the due course of settlement of a business dispute. The father was not going to be able to get anything if he did not settle the dispute on the "oral trust" for his children. Looking at the totality of the transaction, it is apparent it is not a gift. 
This is a case where, again, the IRS is taking a highly technical approach of compliance with nuances of the code and blowing them up into fatal flaws when in fact they never had a case on the facts in the first place.
In terms of lessons learned, referring to the "oral trust" Matt's comment was:
This is an example of one of the greatest dangers, in fact the greatest danger, for a family controlled company - nothing is written down. 
Being in the movie business and all you would think the Redstones. would have been familiar with the remark attributed to Samuel Goldwyn - "A verbal contract isn't worth the paper it's written on."

My own closing comment is that even though there was a favorable result here, I don't think that it would be wise to attempt to do something like this on purpose.