Stock-purchase agreement and insurance proceeds disregarded in valuation of decedent's stock.

• Author: O'Driscoll, David

A recent Eleventh Circuit decision held that a corporation's fair market value (FMV), not a stock-purchase agreement, was the proper basis for valuation of the shareholder's stock at death. However, it also held that insurance policy proceeds used to purchase the decedent's stock under the agreement should not have been included in computing the company's FMV.

Facts

A and B were the only shareholders of E corporation. In 1981, they entered into a stock-purchase agreement requiring E to purchase the holder's stock on his or her death at a price agreed on by the parties. E purchased insurance policies to ensure that the business could continue operations while fulfilling its commitment to purchase stock under the agreement. The policies would provide roughly $3 million, respectively, for the repurchase of A's and B's stock.

After A's death in 1996, B executed an amendment to the stock-purchase agreement that bound B and E to exchange $4 million for the shares B would own at his death. In 1997, B's estate filed a return declaring $4 million as the shares' value. The IRS filed a deficiency notice.

FMV Exceptions

A taxable estate is generally the FMV of the decedent's property at the date of death; see Secs. 2031(a) and 2033. Regs. Sec. 20.2031-2 defines the FMV calculation. That guidance has been refined by the courts into an exception to the general rule for property subject to a valid buy-sell agreement; see True, 390 F3d 1210 (10th Cir. 2004). This exception has three requirements:

1. The offering price must be fixed and determinable under the agreement;

2. The agreement must be binding on the parties both during life and after death; and

3. The agreement must have been entered into for a bona fide business reason and not as a substitute for a testamentary disposition.

Under the Omnibus Budget Reconciliation Act of 1990 (OBRA), the agreement also must (1) have a bona fide business purpose, (2) not permit a wealth transfer to the natural objects of the decedent's bounty and (3) be comparable to similar arrangements negotiated at arm's length; see Sec. 2703 and Regs. Sec. 25.2703-1(b). The OBRA applies to all agreements created or substantially modified after Oct. 8, 1990.

Binding During Life

To qualify for the exception to the general FMV rule, the restrictive agreement must be binding during the decedent's life; see Regs. Sec. 20.2031-2 (h). Here, the 1981 agreement could only be modified by the "parties thereto." By the time the 1996...