One plus one equals two - sometimes! (estate tax valuation of property held in a qualified terminable interest property trust)

• Author: Rhine, David S.

The whole is equal to the sum of its parts--sometimes. A recent Fifth Circuit case points up that the traditional answer is not always true, at least when it comes to valuation.

An estate is taxed on property interests held in several different forms. In addition to property held outright by a decedent, the estate will be taxed on interests over which the decedent held a general power of appointment, as well as trusts in which there is an interest that qualified for qualified terminable interest property (QTIP) treatment. All will be taxed in the estate.

It is well-settled that the concept of the willing buyer-willing seller used for valuing property interests includes premiums and discounts, depending on the size of the interest transferred. But what is the size of the transferred interest?

In Bonner, 84 F3d 196 (5th Cir. 1996), the decedent's estate was taxed on a number of properties. However, the decedent owned a majority interest in his own name in only one of the properties. Interests in the other two properties were held in part in a QTIP trust created under his wife's will and in part by the decedent. In the aggregate, 100% of the ownership of a ranch, real estate and a boat was included, but not all of the interests were directly owned by the decedent. He owned 62.5% of the ranch and 50% of the real estate and the boat; the remainder of the interests was owned by the QTIP trust. The parties did not dispute the total value of the assets (at least not by the time the case got to court).

At stake was how the undivided interests should be valued. The court found the statutory requirement that the QTIP trust be taxed at the death of the surviving spouse did not result in 100% ownership. Disposition of the QTIP interest was established by the first spouse to die. The survivor did not control its disposition and could not merge the interests. Minority discounts were allowed by the court.

In Letter Ruling (TAM) 9608001 (issued prior to Bonner), the IRS ruled on Bonner-type facts. Not unexpectedly...