Estate freeze transactions not covered by Chapter 14.

• Author: Coplan, Robert B.

A direct estate freeze can be accomplished with a lifetime gift to children or grandchildren of stock or a partnership interest in a family enterprise. Post-gift appreciation and earnings on the stock or partnership interest are shifted from the donor's estate to the donees. Any gift tax paid by the parent donor is excluded from the donor's estate, unless death occurs within three years of the gift, in which case the gift tax is added back to the estate under Sec. 2035(c). The overall benefit of removing the gift tax itself from the taxable estate is offset to some extent by the time value of money on the estate tax "prepayment."

Other freeze transactions that might have been reached by repealed Sec. 2036(c) may now be appropriate. For example, after recapitalizing his stock in the family corporation, a parent might choose to retain the common stock and give the preferred stock to his children. The special valuation rules of Sec. 2701 do not apply to this type of transfer.

In such a "reverse freeze," the objective is to minimize the gift tax value of the preferred stock given to the children. Therefore, the parent would usually select noncumulative preferred stock without value supporting features (such as a conversion privilege into the common stock or a liquidation right). As circumstances permit, the corporation then declares and pays dividends on the preferred stock. These dividends reduce the book value and presumably the fair market value of the parent's common stock. Furthermore, the dividends should not be treated as gifts because the gift-taxable event was the initial transfer of the preferred stock. The principal disadvantage to such a transfer is the double taxation of the preferred stock dividend, first at the corporate level and then to the preferred stock shareholder. (Of course, this type of transfer is unavailable for S corporations, since two classes of stock would be involved.)

Sec. 2701 is aimed at preventing undervaluation of common stock given by a parent to his children, based on an excessive value...