Disappearing and reappearing value on a two-way street: the reverse Chenoweth situation.

• Author: Del Duca, George F.
• Position: Tax Law

A major tax strategy in estate planning is to reduce or minimize valuation by creating discounts through gifts of portions of a property or through transferring assets to restrictive entities such as family limited partnerships, limited liability companies, and corporations. (1) Using these techniques, the portion of the value of the assets offset by the discounts "disappears" from the transfer tax base. As a result, the transfer tax that is based on the value of the assets is also reduced or minimized.

In Revenue Ruling 93-12, 1993-1 C.B. 202, the IRS acquiesced to extending the concept of disappearing value to family-owned entities. In the facts of the revenue ruling, the parent owning 100 percent of the family corporation gifted a 20 percent interest to each of his or her five children. The IRS concluded that each gift of a 20 percent interest is to be valued separately as a minority position, allowing the application of a minority discount, as well as a marketability discount. (2) As a result, the portion of the value of the corporation that is reduced by the discounts disappears from the transfer tax base. This is consistent with the basic valuation premise that when valuing the parts separated from the whole, the sum of their values is less than the value of the whole.

In Estate of Chenoweth v. Commissioner, 88 T.C. 1577 (1987), the Tax Court concluded that valuation for purposes of the marital or charitable deductions may not be the same as for purposes of the gross estate. In Chenoweth, the decedent, who owned 100 percent of a closely held company, made a bequest of 51 percent of the stock to his surviving spouse. On the estate tax return, the 100 percent interest was valued at $2,834,033, and a marital deduction was claimed for 51 percent of such amount, or $1,445,357.

In its petition filed with the Tax Court, the estate argued that the marital deduction for the 51 percent bequest to the surviving spouse should be increased by a control premium of 38.1 percent. The IRS accepted the $2,834,033 valuation of 100 percent of the company, but argued that the marital deduction should be limited to 51 percent of such amount. The estate prevailed, with the 51 percent block being valued at $1,996,038 for purposes of the marital deduction, but at $1,445,357 for purposes of the gross estate. The increase to the deduction for the control premium allowed the estate to fund the marital bequest with fewer assets. As a result, more property was allowed to pass to the credit shelter trust that would not be subject to estate tax upon the death of the surviving spouse.

In Chenoweth, the Tax Court assumed that the accepted value of the 100 percent block in the gross estate included a control premium, but if that were the case, the control premium on the 51 percent block could not have exceeded the premium on the 100 percent block. In fact, the control premium for the smaller 51 percent interest would have most likely been less. Rather, the $1,996,038 marital deduction for the 51 percent block was obtained by increasing its $1,445,357 value on the return by 38.1 percent for the control premium, with no control premium or a smaller control premium having been applied in valuing the 100 percent block in the gross estate, which was inconsistent.

Chenoweth drew attention to the need for the valuation of closely held interests passing to the marital and charitable deductions, which led to consideration of the reverse situation of a controlling interest in the gross estate but only a minority interest passing to the surviving spouse or charity. This is the so-called "reverse Chenoweth" situation. In this situation, the minority interest would be valued for purposes of the marital or charitable deduction at less than its percentage share of the value of the interest in the gross estate, with the difference or "mismatch" constituting an increase to the taxable estate. In this situation, the valuation disappearance occurs on the deduction side consistent with the same valuation principles applicable on the gross estate side.

The reverse Chenoweth issue also exists in the case in which the gross estate includes real estate and a fractional interest in the real estate is distributed to the marital or charitable deduction. In this case, the deduction is reduced by the amount of the fractional interest discount.

Interest in the reverse Chenoweth situation has become more intense now3 as a result of the recent Tax Court decisions in Estate of Black v. Commissioner, 133 T.C. No. 15 (Dec. 14, 2009), and Estate of Shurtz v. Commissioner, T.C. Memo. 2010-21 (Feb. 3, 2010), in which an issue was whether the value of limited partnership interests passing to the marital deduction determined the amount of the marital deduction where the underlying assets of the family limited partnership are...