Discounts for built-in gains.

• Author: Schuster, Randi A.
• Position: Taxation

Fair market value (FMV) has traditionally been defined under Regs. Sec. 20.2031-1(b) as the price at which property would change hands between a willing buyer and a willing seller, neither party being under any compulsion to buy or sell and considering all relevant facts and elements of value as of the applicable valuation date.

Prior to 1986, a corporation could liquidate without gain recognition. This rule, known as the General Utilities doctrine, was repealed in 1986. Despite this change, courts still generally refused to allow a discount for taxes payable on liquidation.

A recent Tax Court decision, Estate of Davis, 110 TC 530 (1998), has been deemed "a new inroad in valuation;" it allowed a discount on the value of corporate stock, acknowledging that tax would be incurred on the built-in capital gains that would be recognized if the assets were sold or the corporation liquidated. The appropriateness of the discount was quite apparent, but the court had trouble reconciling it.

The IRS had relied on pre-General Utilities arguments: there should be no discount for the built-in capital gains, because tax planning would have avoided the gain (Piper, 72 TC 1062 (1979)). The Service also relied on prior decisions that denied any reduction for capital gain when there was no liquidation plan or asset sale as of the valuation date (Cruikshank, 9 TC 162 (1947)).

The Davis court found that, when there is no planned liquidation or sale of the corporation's assets as of the valuation date, the full amount of the built-in capital gains tax may not be taken as a discount or adjustment in determining the FMV of the stock in question, even if it is unlikely that the corporation could have avoided any of the built-in gains tax as of the valuation date (e.g., by electing S status). It ruled that a discount or adjustment for some of the built-in capital gains tax should be taken into account in valuing the corporate stock; further, such discount or adjustment should be part of the...