GOOD FOR THE GOOSE...GOOD FOR THE GANDER?

Since U.S. transfer taxes (estate and gift taxes) are calculated on the value of the property transferred, taxpayers seek low values while the IRS seeks high values. When the asset in question is an interest in a business entity (e.g., stock in a corporation), valuation experts recognize that the stock of an entity may be worth less than the value of the assets owned. Valuation adjustments (commonly referred to as "discounts") are typically applied for lack of control, and for lack of marketability.

Sometimes the interests of the taxpayer and the IRS are reversed - the IRS seeks a low value for an asset and the taxpayer seeks a high value. For example, a taxpayer seeks a high value for shares of stock when they are being contributed to charity, so as to maximize his or her charitable income tax deduction. Here, the IRS has to be mindful since the arguments it makes for a low value may be used against it in a later transfer tax case when it is seeking a high value for the same type of asset.

In a recent case, the IRS did not seem too concerned about that, when it argued for (and indeed prevailed in court) for a 35% lack of control discount and a 45% lack of marketabilty discount relating to shares of stock in a corporation. If a taxpayer sought those levels of discount in a transfer tax case, the IRS would clearly have vigorously objected. But here, such levels were acceptable since it the IRS was looking to reduce value.

It is only a matter of time before taxpayers try and use these discount levels in transfer tax cases. Will what was good for the goose, also be good for the gander?

Bradley J. Bergquist, et al. v. Commissioner, 131 T.C. No. 2 (2008).

NO VALUATION DISCOUNT FOR RMA'S

A restricted management account (RMA) is an account under which the owner of cash and/or securities places those items in the hands of an investment manager to manage for an extended period of time. The account agreement usually provides that the items will be kept under such management for a fixed number of years. This allows the account manager to make long term investment decisions, and thus to put less focus on short term profits to retain client business.

Some assert that an ownership interest in an RMA is worth less for gift and estate tax purposes than the assets held in the RMA, by reason of the obligation to keep management with the investment manager for a fixed period of time. The IRS has now issued a Revenue Ruling that such valuation adjustments are inappropriate.

One leg of the IRS position is that a willing buyer would not reduce what they would pay for the underlying assets by reason of them being bound by this management restriction, and thus the willing buyer/willing seller test for value does not justify a reduction. However, if you ask yourself the question, would you pay the same for $1 million dollars in securities that are under such a restriction and as you would pay for $1 million dollars that are not under such a restriction, it seems obvious that you (or any other willing buyer) would pay less in the first circumstance. It doesn''t take a professional appraiser to question the validity of the IRS' conclusion.

The other argument of the IRS is that no reduction is allowed per Code §2703(a)(2). This provision provides that for federal estate, gift, and generation-skipping transfer tax purposes, the value of any property shall be determined without regard to any restriction on the right to sell or use such property, and thus the account management agreement should not give rise to a valuation adjustment.  However, under Code §2703(b), Code §2703(a)(2) will not apply if to a restriction (1) that is a bona fide business arrangement; (2) that is not a device to transfer property to members of the decedent's family for less than full and adequate consideration in money or money's worth; and (3) whose terms are comparable to similar arrangements entered into by persons in an arm's length transaction. The Ruling concludes that this exception does not apply, but provides no convincing argument or precedent why the exception could not be valid in many circumstances.

Therefore, while the Ruling will result in challenges to valuation adjustments taken for RMA's, whether the IRS is correct on this issue is probably still an open question.

Revenue Ruling 2008-35, 2008-29 IRB 116.

RECENT GIFT TAX FLP CASE

Family limited partnership cases typically involve the valuation of partnership interests for estate tax purposes. The same valuation principles are generally involved for gift tax purposes when the subject of a gift is a limited partnership interest.

In Astleford, the Tax Court in a memorandum decision addressed limited partnership valuation issues, in the context of gift taxes. While the case has no groundbreaking precedents, it did address some valuation issues that often come up in the partnership context.

One issue that came up was whether a transferred general partnership interest (which was transferred by the taxpayer to a limited partnership controlled by the taxpayer), should be valued as a partnership interest or as a less valuable "assignee" interest which is valued at less than a full interest due to lack of management rights. The partnership agreement suggested that an assignee had less than full management rights, but nonetheless the Court applied a substance over form analysis to hold that the successor owner (a family limited partnership) held all or almost all of the ownership rights of the transferred general partnership interest and thus should not be valued as a mere assignee interest.

The Court noted that the taxpayer effectively retained the control rights over the transferred interest because the taxpayer was general partner of the transferee partnership. However, if the interest itself did not have control attached to it, under the willing buyer - willing seller valuation standard presumably a buyer would have paid less for the missing control element so this reasoning may be questionable.

Also questionable is that the Court also noted that the transfer documents for the partnership interest did not refer to the transferred interest only as an "assignee" interest. Since the transferee could only receive what the transferee received, and that is what is being valued, the fact that the assignee nature was not specified by the parties should not really impact value.

The Court also allowed a "tiered" discount. First, it allowed a discount for value for the general partnership interest that was transferred to the limited partnership. Then, it allowed a further discount for the value of the limited partnership interests transferred by the taxpayer. Such tiering of discounts is often sought after as a method of creating larger value reductions through a multiple partnership ownership structure than would be the case with only one partnership involved. However, the general partnership had been in existence for more than 20 years before the transfer to the limited partnership - there is a reasonable likelihood that the Tax Court if faced with a similar arrangement but with recently created multiple tier partnerships would not be so generous in allowing for tiered discounts.

Astleford, TC Memo 2008-128.