Case — Asset Valuation Discount

Thanks for sharing!

TL Case Summ

THE QUESTION

Can an estate reduce the value of its interest in a corporation for the full amount of potential capital gains tax?

THE DISPUTE

Taxpayer Says: A buyer would have to pay capital gains tax upon liquidating the corporation and would therefore require a discount before purchasing the corporation from the estate. The value of the corporation should be reduced by 100% of the estimated capital gains tax.

Internal Revenue Service Says: The discount should be less than 100% of the capital gains tax because a buyer can find ways to reduce or eliminate the tax.

THE LAW

From Internal Revenue Code Section 2031(a): Property includable in the value of a gross estate is to be valued as of the date of the death.

From Federal Tax Regulation 20.2031-1(b): For purposes of the estate tax, property value is determined by finding the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.

From Eisenberg v. Commissioner, 155 F.3d 50 (2d Cir. 1998): The Court of Appeals for the Second Circuit held that a discount for built-in capital gains tax was allowable. The court did not determine the amount of the discount.

From Estate of Dunn v. Commissioner, 301 F.3d 339 (5th Cir. 2002) and Estate of Jelke v. Commissioner, 507 F.3d 1317 (11th Cir. 2007): The Courts of Appeals for the Fifth and Eleventh Circuit allowed discounts for the built-in long term capital gains tax in full.

THE CAUSE OF THE DISPUTE

Editorial Note. While this opinion involves estate tax, which is not in effect for 2010 (though presently scheduled to return in 2011), the valuation and discount issue also has implications for other areas of tax law. The estate in this case began in 2005.

Under prior estate tax law (and potentially future law as well), assets in an estate are valued at fair market value. When those assets include the stock of a corporation that is owned by relatively few shareholders (a “closely-held” corporation), the value of the stock is generally determined by an appraisal. The appraisal can take into account factors that make the stock worth less to a buyer, and reduce or “discount” the value by those factors.

For a closely-held corporation, one factor that can reduce the value is the amount of capital gains tax a buyer would have to pay upon liquidation of the corporation.

In this case, the estate included stock in a closely-held corporation that owned real estate. The estate deducted the full amount of capital gains tax that would be due upon the sale of the real estate on the premise a buyer would demand this amount as a discount to the sales price.

The IRS says the discount should be less than 100% because there are numerous methods by which potential buyers of the stock could avoid or defer the tax.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 38KB)

***

HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

***

Other posts you might enjoy

Decisions — Taxing choices Image source: Free Picture © Semen Barkovskiy Dreamstime Stock Photos   How many options can you consider before you find yourself longing for simplicity? Whatever your answer, part of the desire for less complexity comes from not wanting to make the wrong choice. That's especially true ...
Decisions — Where’s your refund? Image source: By U.S. National Archives and Records Administration, Public domain, via Wikimedia Commons Where's your refund? Possibly helping to reduce the federal budget deficit, if you failed to file a return to get an overpayment back within the applicable time period. That's because the gov...
Case — Fun and games Image source: openclipart.org (public domain image) THE QUESTION Does an organization that offers a recreational activity to achieve a charitable purpose qualify as a charitable organization? THE DISPUTE Taxpayer Says: It operates for charitable purposes because it provides relief for the p...
Case — Carry On THE QUESTION Can an IRA deduction that is disallowed due to active participant status in an employer plan be carried forward and deducted in a future year? THE DISPUTE Taxpayer Says: The 2008 IRA contribution was an “excess contribution” and should be allowable as a deduction in 2010. Intern...
Right answer!
Sorry, wrong answer :(
For the Taxpayer. We are not convinced that any viable method for avoidance of the built-in long term capital gains tax exists for a hypothetical buyer of the estate’s stock. Thus, we do not think the discount for the built-in long term capital gains tax is significantly reduced.