ALI-ABA PLANNING TECHNIQUES FOR LARGE ESTATES IS VALUATION THE BEST PLANNING GAME REMAINING? PART II 2000 2003 Byrle M. Abbin Wealth & Tax Advisory Services, Inc. McLean, VA TABLE OF CONTENTS Page I. FRACTIONAL INTERESTS K. 60% Discounts Applied in Valuing Partial Timber Interests in Trust 1 II. CONTROL/DECONTROL DISCOUNTING C. Stock valuation varies for gross estate and marital/charitable deduction purposes 2 D. Control premium 4 E. Transfers to remove control 5 G. Control Matters Outside of Gifts and Estates IRS Argues 50% is not Control Under Controlled Foreign Corporation (CFC) Rules; Tax Court Agrees 7 IV. BUY/SELL AGREEMENT RECOGNITION H. Tax Court Finds Buy-Sell Agreement Based on Book Value is Testamentary Alternative 8 V. VALUATION DISCOUNTS/IMPORT OF POST TRANSACTION EVENTS M. Built in Capital Gains Tax Relevance 11 Z. Attacks on Family Partnerships 17 CC-AAAA Special Fact Pattern Valuation Situations 47 VII ACTUARIAL TABLES APPLICATION G. Government Denied Summary Judgment on Use of Tables for Lottery Payments, Then Loses on Valuation 80 K. Goodbye Gradow and Past Ninth Circuit Rejects Use of its Decision in Past Requiring Value of Entire Property Interest to Meet Adequate and Full Consideration for Remainder Sale / 2036(a) 81 M. Tables Apply Unless Terminal Affliction Known at Date of Transfer 83 2003 Byrle M. Abbin.
ALI-ABA PLANNING TECHNIQUES FOR LARGE ESTATES IS VALUATION THE BEST PLANNING GAME REMAINING? Byrle M. Abbin Wealth & Tax Advisory Services, Inc. McLean, VA FRACTIONAL INTERESTS K. 60% Discounts Applied in Valuing Partial Timber Interests in Trust The estate tax values of two decedent spouses' respective partial interests in a trust that held timberland were determined by applying a 60-percent fractional interest discount to the proportionate interests. The spouses and three of the wife's relatives established the trust for the purpose of keeping 16 parcels of Louisiana timberland held by the various family members in undivided ownership. The spouses died within one year of each other, with the husband and wife owning 21.54-percent and 26.15-percent interests in the trust, respectively. The remaining trust interests were owned by the wife's brother (who managed the trust properties) and her nephew and niece. The trust permitted the sale of an interest only with the consent of all of the beneficiaries. On amended estate tax returns, the estates of both the husband and wife applied 60-percent fractionalization discounts in valuing the trust interests, after having initially claimed discounts of 25% and 50%, respectively. The Tax Court agreed with the estates that a 60-percent fractional interest discount was appropriate in valuing the spouses' partial interests in the timberland held through the trust. The court held that the estates' experts, by use of comparable sales of fractional interests in timberland, established that the average discount historically applied in valuing such partial interests was 55 percent. The court particularly relied on one of the estates' three experts, concluding that his personal knowledge and practical experience in the Louisiana timberland market made his testimony especially germane. In contrast, the court found that the IRS's expert was not specifically qualified to assist in making a determination as to the amount of the discount. The increase in the discount to 60 percent was warranted in order to reflect the difficulties associated with partition under Louisiana law and to account for the circumstances peculiar to the other family members that would influence a knowledgeable hypothetical buyer. As examples of these specific circumstances, the court cited the family's past disagreements regarding the use of the property and the prior mismanagement of the property by the wife's brother. Baird Est. v. Commissioner, T.C. Memo 2001-258. 2003 Byrle M. Abbin. 1
II. CONTROL/DECONTROL DISCOUNTING C. Stock valuation varies for gross estate and marital/charitable deduction purposes 3(a) Estate Must Value Voting Common as a Unit; IRS Claims $182 Million Deficiency on Lower Value for Charitable Bequest of the Same Shares of Stock The Tax Court accepted IRS' request for summary judgement that decedent's control block of voting shares and nonvoting common should be aggregated as a unit for valuation. Because of ambiguous document drafting and a nonmandatory redemption agreement with a foundation to be set up as the donee of this stock, the court refused taxpayer's request for summary judgement that the redemption price establishes FMV for estate inclusion purposes. Since heirs sued the estate re the foundation redemption agreement, IRS asserted that only the common stock had to be redeemed. Even though the nonvoting stock was convertible into voting stock, it was attributed a lower value for Sec. 2055 charitable deduction purposes. Thus Chenoweth and DiSanto apply, whip sawing the taxpayer with a lower value for deduction than inclusion, even though all the shares went to charity, resulting in a $182 Million deficiency (reduced from an initial $416 Million). Summary judgement was not given to IRS on this point regarding the value of the charitable contribution; controlling state law and the testator's intent in establishing the redemption agreement will have to examined in a full trial. Commentary: I have no problem with utilizing the unitary approach for valuing the stock in the gross estate; that has been established for some time by Curry v. US, a 1983 seventh circuit case. IRS' position re the charitable deduction being a lesser amount, even though the charity received the same asset (in form and amount) as was included in the gross estate, is most troubling. Yet the lesson to be learned is that careless or ambiguous document language gave IRS entré to make their argument and the estate will have to sweat out a full trial on this point. The unity of interest theory apparently is not being followed by many appraisers, especially for a decedent who owns a controlling GP interest as well as LP interests in a partnership. Based on Schwan and Curry, this appears to be contrary to IRS and the court's view, and thus subject to challenge. Schwan v. Comm., T.C. Memo 2001-174, reproduced in 2001 TNT 136-11, July 16. 3(b) Charitable Bequest of Art Subject to Restrictions: No Reduction in Value A testamentary transfer of an art collection was subject to a number of restriction on mode of display as a unit, maintenance of condition and security, continuous exhibition, proper attribution to the donor and lending limitations. IRS ruled that the value of the charitable bequest was equal to the value in the gross estate: value was not diminished by the restrictions since the recipient institution could not be divested of the art collection, restriction on sale was limited to art similar in quality to deaccessioned works and the museum could loan art from the colleaction even if limited to a temporary period. A lengthy analysis of this PLR and contrasting its results to cases like Schwan, where stock was valued higher in 2
the gross estate than for charitable dedeuction purposes, can be found in Fox, Restrictions on Charirtable Bequests Of Arts: Recent PLR Paints a Picture, 29 Estate Planning 452 (September 2002). PLR 200202032. 4(a) Aggregation of Directly Owned Shares and General Power of Appointment Marital Trust Owned Shares into One Block W funded a marital trust under will for H, with 44% of Family company stock; 6% went thereunder to the Residuary Trust. H owned directly the other 50%. In a Field Service Advise the IRS National Office Branch 4 chief concluded that the two interests of H should be aggregated. IRS stated that H had total control and the "functional equivalent" of outright ownership over the marital trust assets. Thus, no statutory authority is required to aggregate and the stock is valued as a 94% block owned by H. IRS distinguished Bright, Popstra, Bonner, Lopes, Nowell, and Mellinger, (the latter four cases involving Q-Tips) where decedent had no control over the trust assets. Section 2044 is inapplicable and Sections 2041 (power of appointment) and 2033 (general conclusion) are treated as alter ego provisions thus, control existed at death over the trust by virtue of the general power of appointment. This FSA apparently is related to the taxpayer who petitioned the Tax Court, Fontana v. Commissioner, Tax Court Docket No. 6635-00. FSA 200119013. (b) Tax Court Aggregates Outright Ownership With General Power of Appointment (P/A) Over Trust to Obtain Control Block for Valuation Not surprisingly even the most taxpayer inclined judge on the Tax Court concluded that a surviving spouse who directly owned a 50% block of stock, and who was the beneficiary of a trust over which he had a general power of appointment that owned a 44.069% block, should be treated as owning 94%, the blocks being aggregated for estate valuation. This resulted in an amount about 20% higher than the taxpayer reported by valuing each block separately, (the 50% block being valued 18% higher by the taxpayer than the trust interest subject to a general P/A). The court concluded that Mellinger was not applicable, since there the second block was in a QTIP trust, over which the individual had no power to control and it was deemed to be owned and passed from the decedent QTIP trust beneficiary solely for estate tax marital deduction and inclusion purposes. On the other hand, a general P/A is tantamount to outright ownership based on long standing case law. It also rejected arguments that Popstra, Bright and Est. of Bonner precludes aggregation by requiring that attribution of ownership as a unity be ignored. In those three cases the government lost, since it tried to combine ownership of two separate individuals, while in Adams the same individual was determined to have two outright ownership interests in the same entity's stock. 3
Commentary: Obviously Mellinger et al continue to have viability to allow taxpayers to claim minority and/or non-majority discounts, where the second block is held by a QTIP or similar restricted ownership entity. Est. of Fontana v. Commissioner 118 T.C. No. 16 (03/28/02) 5. IRS Attempts to Aggregate FLP Interests Owner By QTIP and Second Marital Trust Obtained in Post-Mortem Recapitalization A Tax Court petition summary can be found at V.Z.22. Est. of Maitland v. Comm., (No. 6012-01), TNT 145-55 (July 27, 2001) 6. IRS Allows No Discount for 49.6% Direct Shareholding and Two 23.665% QTIP Interests Surviving spouse had two QTIP interests, each trust comprising 23.665% of the stock of a family corporation whose primary function was owning listed securities. Upon her death she also had direct stock ownership of 49.67% in the same family company. The taxpayer s expert provided an appraisal focusing upon (1) a lack of a shareholder's or put agreement; (2) only nominal dividends had been paid; (3) there was no prospect of a public offering; and (4) a minority interest was involved. IRS denied a 15% minority interest discount and a 30% lack of marketability discount claimed by taxpayer based on this "independent qualified appraisers" report. The "30-day letter" rationale for denial of these discounts, applied consistently to all 3 of the interests in Day Stores as representing the stated seriatim minority and lack of marketability discount, is that these discounts were "excessive." A built-in capital gains tax discount amounting to 20.8%, was reflected by IRS, since the estate represented it will liquidate the company where the estate is closed. Est of Brownstone v. Comm., Tax Court Docket No. 257-01. D. Control premium 4(a) Minimal Option Price to Child Ignored as Testamentary Alternative; 50/50 General Partnership Interest Not Subject to Minority Discount Five partnership agreements between dad and son, each a 50% GP, allowed son to buy for a minimal amount. An appraiser involved in son's former wife's suit against him set out a 25% discount for lack of marketability and a 15% discount for lack of control. The Tax Court ignored the options as affecting value, since they were considered to be testamentary alternatives, reduced the nonmarketability discount to 20% and denied a minority discount on the basis that disregarded the fact that dad had assigned irrevocable management of the partnership to son, since the agreement itself did not reduce his interest to that of a minority. No reference was made to Est. of Frank or Wheeler where minority discount was reflected for a 50% interest. Commentary: A willing buyer surely would consider its interest as a minority under these facts. The Judge was not realistic in his analysis. Est. of Godley v. Comm., T.C. Memo 2000-242. 4