Redstone's small (for him) tax victory

The legal troubles of Sumner Redstone are not limited to the proceedings going on in Los Angeles County Superior Court over his capacity and the right to make his medical decisions. In Redstone v. Commissioner, U.S. Tax Court, CCH Dec. 60,467(M) (Dec. 9, 2015) the Internal Revenue Service has won a decision against the 92-year-old majority owner of CBS and Viacom which further explores the dysfunction that often plagues wealthy families, including the Redstones.

Sumner Rothstein was born May 22, 1923, to Michael ("Mickey") and Belle Rothstein in Boston, Massachusetts. (Mickey changed the family name to Redstone in 1940.) Mickey had built a successful business owning and operating drive-in movie theaters, and after graduating Harvard College in 1944, Harvard Law School in 1947, and a short stint in both public and private law, Sumner joined his father and his older brother Edward in the business in 1954.

A series of recapitalizations resulted in Mickey, Edward and Sumner each owning one-third of the resulting corporation, National Amusements Inc., even though neither Sumner nor Edward had contributed a full third. When a dissatisfied Edward decided to leave NAI in 1971, he demanded his shares of the corporation, and Mickey refused to surrender them. Litigation ensued. Mickey took the position that Sumner and Edward had contributed only approximately 25 percent toward their one-third interests, with the balance held in an oral trust for their respective children. Mickey would only resolve the litigation if Edward would agree to transfer one-third of his interest, one-ninth of the total, to a trust for his children, Michael and Ruth Ann, and Edward agreed. Three weeks after that deal was struck, Sumner, although not bound by the settlement, transferred a similar percentage to a trust for his two children, Brent and Shari. The settlement was completed in June 1972.

Following an analysis by his certified public accountant, Sumner was advised that the transfer of shares to his children was not a gift. Accordingly, Sumner and his wife Phyllis filed no gift tax return for 1972.

Shortly thereafter, the IRS launched an unrelated investigation following the Watergate controversy into the affairs of a small number of wealth political contributors, including Sumner. Although they were not looking for intra-family gifts but rather gifts to political organizations, the IRS concluded that Sumner had no obligation to file a gift tax return for 1972.

The matter would not have come to the attention of the IRS again but for further litigation brought in 2006 by Edward's son Michael, who claimed that the shares set aside for him in trust as part of the 1972 settlement were subsequently improperly redeemed by the corporation. In that litigation, Sumner acknowledged under oath that he had put his shares in trust for his children voluntarily to please his father, not because it was required by the settlement. That testimony came to the attention of the IRS, and they reopened an examination of Sumner's gift tax liability for 1972.

In January 2013, the IRS determined a 1972 gift tax deficiency of $737,625 for the value of the gifts, plus additions of $368,813 for fraud, $36,881 for negligence, and $184,806 as a penalty for failing to file a return; a total of $1,328,125.

Dealing first with procedural issues, the Tax Court held that the prohibition against a second examination under Internal Revenue Code Section 7605(b) did not apply, both because the earlier examination was focused only on political contributions and because Sumner failed to object on that basis until nearly a year after the IRS had issued its notice of deficiency. No return having been filed, the notice of deficiency issued 41 years after the transfer was held timely. Sumner raised the issue of laches, noting not only his advanced age but that "material witnesses have been dead for decades; documents had long since been discarded or have disintegrated; memories have unquestionably eroded." The court denied this defense holding that the equitable defense was only available if it was demonstrated that the IRS was aware of the 1972 gifts but sat on its rights and that the taxpayer suffered undue prejudice as a result. Finding no such demonstration, the defense of laches was rejected.

The Tax Court then dealt with the underlying substantive dispute, rejecting Sumner's contention that the shares were transferred to trust for the benefit of his children as part of the overall settlement in which he engaged with his father and brother and not as a gift. In a companion audit of the liability of Sumner's now-deceased brother Edward, the Tax Court held that Edward's 1972 transfer of stock to his children was not a gift, but made in the ordinary course of business to settle the litigation in which Edward was engage, and thus for full and adequate consideration. Although Sumner entered into the same transfer only three weeks after settlement of Edward's litigation, the court found that Sumner was not bound to make the transfer, that he did so to appease his father, and that the shares were transferred to his children not in settlement of a claim, but were motivated by the kinship he had with his father and his children, all bearing the hallmarks of donative intent.

In a small victory for Sumner, the court held that a reasonable cause defense existed for the additions, as Sumner sought and received advice from competent tax advisors, and that there was no evidence of fraud. The court noted that Sumner has filed 34 federal gift tax returns in the course of his life, beginning in 1970 and ending in 2012. On the basis of the advice he received, the court concluded that Sumner was not liable for any of the additions to the gift tax.

Mark J. Phillips is a partner with Goldfarb, Sturman & Averbach in Encino, and the co-author (with Aryn Z. Phillips) of "Trials of the Century: a Decade-by-Decade Look at Ten of America's Most Sensational Crimes," due out from Prometheus Books in July of 2016.