## Facts

- Robert E. Cartwright died in 1988 while serving as majority shareholder and a leading revenue generator for a law firm organized as CSB.
- CSB attorney compensation consisted of salary plus profit-based bonuses, and a shareholders’ agreement governed post-death rights and stock disposition.
- Shortly before Cartwright’s death, CSB amended the shareholders’ agreement as to him, requiring CSB to obtain roughly $5 million in life insurance.
- The amendment directed the insurance proceeds to be paid to Cartwright’s estate both (i) for his CSB stock and (ii) for any claims “to any cases or work in process” otherwise assertable on his behalf.
- After Cartwright’s death, CSB received over $5 million in insurance proceeds and paid about $5,062,029 to the Estate under the amended agreement.
- The Estate did not report the payment as income; CSB reported $4,080,256 of the payment as compensation.
- The IRS determined that a substantial portion of the payment was “income in respect of a decedent” (IRD) under I.R.C. § 691 and assessed an income tax deficiency of about $1.1 million.
- The Tax Court held the payment was partly for stock and partly for “cases or work in process,” treated the latter portion as IRD, and valued Cartwright’s stock using a methodology the Estate challenged, including treatment of work in process, advanced client costs, and exclusion of insurance proceeds as a firm asset.

## Issues

1. Whether the insurance-funded payment to the Estate was solely a stock redemption or also compensation for Cartwright’s interest in “cases or work in process,” making that portion IRD under I.R.C. § 691.
2. Whether the Tax Court correctly valued Cartwright’s law-firm stock, including its treatment of advanced client costs and work in process.
3. Whether the life-insurance proceeds should be treated as a nonoperating firm asset when valuing the stock.

## Decision

- The Ninth Circuit affirmed that the payment was partly for Cartwright’s stock and partly for his claims to “cases or work in process.”
- The court affirmed that the portion attributable to “cases or work in process” constituted IRD taxable to the Estate under I.R.C. § 691.
- The court affirmed in part and reversed in part the Tax Court’s stock valuation, holding the valuation should account for advanced client costs and work in process.
- The court held the life-insurance proceeds should not be included as a separate positive (nonoperating) firm asset for valuation because they were offset by CSB’s contractual obligation to pay the Estate.
- The case was remanded for redetermination of the stock value consistent with these holdings.

## Legal Principles

- When a governing agreement expressly allocates a payment to both stock redemption and a decedent’s interest in pending matters (e.g., “cases or work in process”), the portion attributable to the pending-matters interest may be IRD under I.R.C. § 691.
- IRD includes amounts to which the decedent had a right at death that are received later by the estate and were not properly included in the decedent’s final income tax return.
- Valuation of equity in a professional firm for tax purposes should consider items that affect firm value, including work in process and advanced client costs.
- Insurance proceeds earmarked by contract to fund payments to a decedent’s estate generally should not increase firm value for stock-valuation purposes where the proceeds are matched by an enforceable obligation to pay them out.

## Conclusion

The Ninth Circuit held that an insurance-funded payout to a deceased law-firm shareholder’s estate was partly taxable IRD because the contract directed payment for “cases or work in process,” and it remanded for revised stock valuation requiring consideration of work in process and advanced client costs while excluding the insurance proceeds as a net firm asset.


Estate of Cartwright v. Commissioner, 183 F.3d 1034 (9th Cir. 1999)