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Kress v. United States

United States District Court, E.D. Wisconsin

March 25, 2019

JAMES F. KRESS and JULIE ANN KRESS, Plaintiffs,
v.
UNITED STATES OF AMERICA, Defendant. James 2007 Julie 2007 Combined 2007 Year Emory Czaplinski Burns IRS

          FINDINGS OF FACT AND CONCLUSIONS OF LAW

          WILLIAM C. GRIESBACH, CHIEF JUDGE

         Plaintiffs James and Julie Kress brought this tax refund action against the United States of America to recover an overpayment of gift taxes and interest related to Plaintiffs' gift of minority-interest stock in Green Bay Packaging, Inc. (GBP) to their children and grandchildren they claim were erroneously assessed and collected by the Internal Revenue Service for the 2007, 2008, and 2009 tax years. This court is asked to decide the fair market value of the minority-interest stock for these tax years. The court has jurisdiction pursuant to 28 U.S.C. § 1346(a)(1). A trial to the court was held on August 3 and 4, 2017. After the close of testimony and evidence, the parties submitted post-trial briefs. Having now considered the record, I make the following findings of fact and conclusions of law.

         BACKGROUND AND EVIDENCE

         I. Procedural History

         Plaintiffs are shareholders in GBP, a family-owned subchapter S-corporation with its corporate headquarters in Green Bay, Wisconsin. Founded in 1933 by George Kress, GBP is a vertically integrated manufacturer of corrugated packaging, folding cartons, coated labels, and related products. At the time this case was filed, GBP employed approximately 3, 400 people in 14 states. Although GBP has the size and wherewithal to be a publicly-traded company, it has remained the closely held family company its founder envisioned. Approximately 90% of the company's shares of common stock are owned by the Kress family, and the remaining 10% are owned by GBP's employees and directors. Between 1990 and 2009, GBP paid annual dividends, ranging from $15.6 million to $74.5 million, to its shareholders each year.

         The purchase price for shares sold by GBP to its employees and directors is 120% of the book value of each share. While there is an established price for the sale and purchase of GBP shares by employees and directors, there is no price established for shares that are transferred to members of the Kress family. Certain restrictions limit the ability to sell both family shares and non-family shares of GBP stock. The right-of-first-refusal restriction contained in the GBP Bylaws requires that an employee or director shareholder give GBP written notice of his intent to sell and offer to sell the shares to GBP before selling to others.

         The Bylaws also contain a Family Transfer Restriction that limits how members of the Kress family may transfer their shares:

Transfer of shares of the Corporation by shareholders who are members of the Kress Family . . . is hereby restricted to transfers by gift, bequest or private sale to a member or members of the Kress family, provided, however, that the children of George and Marguerite Kress may transfer shares of the Corporation by gift to such child's spouse or trust therefor and further provided that in the event of any such transfer as above provided to issue and descendants or spouse of a child or trust therefor of George and Marguerite Kress, that all of the restrictions set forth herein shall continue to be applicable to the shares of common stock then held by such issue and descendants or spouse or trust therefor as transferee.

         Trial Ex. 26 at 10-11. In short, the Restriction requires that the Kress family only gift, bequest, or sell their shares to other members of the Kress family. Plaintiffs maintain that the Kress Family Transfer Restriction ensures that the Kress family retains control of GBP, minimizes the risk of disruption to GBP's affairs by a dissident shareholder, ensures confidentiality of GBP's affairs, and ensures that all sales of GBP minority stock are to qualified subchapter S shareholders. As part of their estate planning, most of the senior members of the Kress family, including Plaintiffs, have annually gifted equal amounts of GBP stock to the younger members of their families. From 1997 to the present, no junior member of the Kress family has gifted GBP shares to a more senior family member and no member of the Kress family has gifted shares of stock to another member of the family at the same generational level.

         Plaintiffs gifted minority shares of GBP stock to their children and grandchildren in 2006, 2007, and 2008. Plaintiffs each filed gift tax returns for tax years 2007, 2008, and 2009 to report the gifts and identified on their respective returns the fair market value for the gifted shares: $28.00 for tax year 2007, $25.90 for tax year 2008, and $21.60 for tax year 2009. Plaintiffs each paid $1, 219, 241 in gift taxes with respect to the gifted shares, for a combined total of $2, 438, 482.

         The IRS challenged the amounts Plaintiffs reported on their gift tax returns by letter dated November 30, 2010. On August 19, 2014, the IRS sent Plaintiffs separate Statutory Notices of Deficiency for the tax years at issue. After examining the returns, the IRS assessed deficiencies, finding that the fair market value of Plaintiffs' stock equaled the price used for actual share transactions between GBP and its employees which was $45.97 on December 31, 2006; $47.63 on December 31, 2007; and $50.85 on December 31, 2008. Plaintiffs paid the gift tax deficiencies and accrued interest, totaling $2, 218, 465.80, in December 2014 in the amounts show below:

James 2007
Julie 2007
Combined 2007

Paid

$274, 941.00

$274, 941.00

$549, 882.00

Interest

$75, 416.54

$75, 416.54

$150, 833.08

Total

$350, 357.54

$350, 357.54

$700, 715.08

James 2008

Julie 2008

Combined 2008

Paid

$271, 353.00

$271, 353.00

$542, 706.00

Interest

$56, 229.65

$56, 229.65

$112, 459.30

Total

$327, 582.65

$327, 582.65

$655, 165.30

James 2009

Julie 2009

Combined 2009

Paid

$371, 841.00

$371, 840.00

$743, 681.00

Interest

$59, 452.29

$59, 452.13

$118, 904.42

Total

$431, 293.29

$431, 292.13

$862, 585.42

James Total

Julie Total

Combined Total

Paid

$918, 135.00

$918, 134.00

$1, 836, 269.00

Interest

$191, 098.48

$191, 098.32

$382, 196.80

Total

$1, 109, 233.48

$1, 109, 232.32

$2, 218, 465.80

Plaintiffs then filed amended gift tax returns for tax years 2007, 2008, and 2009 seeking a refund for the additional federal taxes and interest they paid. After six months elapsed without receiving a response from the IRS regarding Plaintiffs' request, Plaintiffs initiated this lawsuit on June 24, 2016, to recover the gift tax and interest they were assessed.

         II. Green Bay Packaging

         GBP is an established company with a strong balance sheet and has little debt compared to its equity as of the valuation dates. From 2002 to 2008, GBP's net sales increased. GBP's net income increased overall from 2005 to 2008. In 2007, its net income decreased by more than $28 million but rebounded in 2008 by more than $33 million. The drop in GBP's net income was caused primarily by the extraordinary costs incurred for maintaining GBP's Arkansas Mill. Recognizing the value of the S-corporation structure, GBP did not seriously consider terminating its S-corporation election as of the valuation dates. In a May 2007 presentation, GBP management reported to their shareholders that they expected to save a total of $238.4 million in taxes between 1988 and 2006 by virtue of the classification as an S-corporation.

         GBP has three non-operating assets: Hanging Valley Investments LLC, group life insurance policies, and two GBP private airplanes. Hanging Valley Investments LLC is a wholly-owned subsidiary of GBP that was created in 2005 to manage GBP's long-term investments. During the relevant time period, Hanging Valley had investments in mezzanine financing obligations, private equity funds, real estate investment funds, gas, oil, and other commodities. Hanging Valley contributes to GBP through appreciation of its investments, which GBP uses for operations and to pay dividends. During the years in question, Hanging Valley's assets were $65, 002, 000.00 on December 31, 2006; $71, 451, 000.00 on December 31, 2007; and $77, 312, 000.00 on December 31, 2008. GBP identified Hanging Valley as a non-operating asset and its cash flow projections listed Hanging Valley as a non-operating item.

         GBP also has group life insurance policies on key employees and shareholders with substantial cash values. The policies are intended to provide reserve for specified events that will occur in the future, such as to assist with estate tax issues when a major shareholder passes away. The only corporate liabilities associated with the cash value of GBP's life insurance policies are a deferred compensation plan for selected employees and a non-qualified retirement pension program for certain executives. The cash surrender value of GBP's life insurance policies for the relevant years was $142, 240, 000.00 on December 31, 2006; $151, 672, 000.00 on December 31, 2007; and $158, 259, 000.00 on December 31, 2008. The cash surrender value of the policies, less the associated corporate liabilities of deferred compensation and non-qualified pension obligations was $86, 025, 000.00 on December 31, 2006; $104, 243, 000.00 on December 31, 2007; and $111, 434, 000.00 on December 31, 2008. GBP identified the cash value of the life insurance as a non-operating asset.

         Finally, GBP owned two private aircraft in 2007, 2008, and 2009. On average, the planes were used half of the time for business purposes and the other half for the Kress family's personal purposes. GBP's cash flow projections identified a portion of GBP's aircrafts as non-operating items.

         FINDINGS OF FACT AND CONCLUSIONS OF LAW

         I. Preliminary Matters

         Before turning to the principal issues presented, the court will address certain preliminary matters. At trial, the Government objected to the admission of Plaintiffs' proposed exhibits 2, 3, 4, and 27 on relevancy grounds. Exhibits 2 through 4 are letters from the IRS to Plaintiffs conveying the IRS' determination that the stock was undervalued on Plaintiffs' original gift tax return and Exhibit 27 is an internal IRS memorandum analyzing Plaintiffs' position and explaining the agency's considerations and determinations regarding the issues presented in valuing GBP's stock. The Government argued that, because IRS administrative considerations and determinations are legally irrelevant to de novo proceedings, they are inadmissible under Federal Rules of Evidence 401, 402, and 403. The court took the Government's objection under advisement.

         The court now sustains the objection regarding the admission of Exhibits 2, 3, 4, and 27 into evidence. Courts do not evaluate the procedure and evidence used in making a tax assessment but rather conduct a de novo review of the correctness of the assessment. Ruth v. United States, 823 F.3d 1091, 1094 (7th Cir. 1987); see also R.E. Dietz Corp. v. United States, 939 F.3d 1, 4 (2d Cir. 1991) (“The factual and legal analysis employed by the Commissioner is of no consequence to the district court.”). The IRS administrative documents showing the agency's consideration of the issues presented in this case or the IRS' rationale for making its determinations has no bearing on the court's de novo determination of the fair market value of a minority-interest stock in GBP for the 2007, 2008, and 2009 tax years. Therefore, any evidence regarding the IRS' administrative considerations and determinations is irrelevant and will not be considered.

         Plaintiffs have also filed a motion requesting that judicial notice be taken of the following facts related to the 2008 economic recession:

• On January 2, 2008, the Dow closed at 13, 043.96, and on December 31, 2008, the Dow closed at 8, 776.39, an almost 34% decrease.
• The Dow hit its pre-recession high on October 9, 2007, closing at 14, 164.43. Less than 18 months later, it had dropped more than 50% to 6, 594.44, on March 5, 2009.
• On September 15, 2008, Lehman Brothers declared bankruptcy. The Dow dropped 504.48 points that day.
• On September 16, 2008, the Fed announced it was making an $85 billion “loan” to AIG in return for 79.9 percent equity.
• On September 29, 2008, the Dow fell 777.68 points, the most in any single day in history.
• The U.S. economy lost 159, 000 jobs in September 2008.
• The U.S. economy lost 240, 000 jobs in October 2008, and the AIG bailout ...

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