Establishing the estate value of stock by using a buy-sell agreement.

• Author: Ellentuck, Albert B.
• Position: Case study

Facts: Arthur Freed owns half of Arthur, Inc.; Henry James owns the other half. Henry and Arthur are not related. The value of each owner's stock is $200,000.

Arthur has conducted extensive estate planning during the last year and his assets (net of liabilities secured by or related to the assets) currently include:

Stock in Arthur, Inc. $200,000 Farm (special use valuation) 400,000(*) Other assets 150,000 Total net assets includible in the estate $750,000 (*) The actual fair market value of the farm is $700,000.

Arthur's only son, Jason, will inherit all of the property when Arthur dies. Jason is not interested in working for the corporation after his father's death, and Henry is afraid Jason will sell the stock to an outside party when he inherits it. Henry has proposed that he and Arthur enter into a buy-sell agreement. Under the terms of the proposed agreement, the stock of the first to die (Arthur or Henry) would be bought from his estate. Henry has proposed the sales price be $200,000 (the stock's current value). Both Arthur and Henry are aware that the value of the stock could increase in the future, although this possibility is considered unlikely.

Arthur wants to establish the current value of his stock as the value to be included in his estate, to avoid having to include any potential appreciation. He has asked his tax adviser whether a buy-sell agreement is an effective way to do this. Issue: Will a buy-sell agreement establish the estate value of the stock?

Analysis

Property generally is valued for estate tax purposes based on its most profitable use. Often the most profitable use of farmland is not farming, especially if the farm is near an urban area. It might be much more profitable to sub-divide the land for construction of homes. Valuation based on that use of the property can result in estate taxes so high the heirs are forced to sell the land rather than continuing farming. By electing special use valuation under Sec. 2032A, an estate can value qualifying property based on its actual (rather than on its most profitable) use.

To qualify for special use valuation, the value of the farm must be at least 50% of the estate's total net assets (i.e., gross assets minus liabilities secured by or related to the assets), and at least 25% of the adjusted gross estate must be qualified real property. Arthur is aware of the special use election and knows, based on current values, the farm is worth at least 50% of his total net assets...