Significant recent developments in estate planning.

• Author: Nager, Ross W.
• Position: Part 2

Cases and Rulings on Valuation; Charitable Giving; Marital Deduction; Generation-Skipping Transfer Tax; Chapter 14; and Miscellaneous Estate and Gift Tax Matters

Part I of this article, published in November, contained "headlines" (important or controversial events) and significant developments in gift taxation; disclaimers; debts, claims and administration expenses; powers of appointment and retained interests; and S corporation issues. Part II, below, covers developments in valuation; charitable giving; marital deduction; generation skipping; Chapter 14; and miscellaneous estate and gift tax matters. The summaries of developments will be supplemented by editorial comments and planning hints.

Valuation

Recent developments in the area of valuation included:

[] Stock revalued due to disallowed buy-sell agreement resulted in increased marital deduction.

[] Discounts determined for various real estate and stock holdings. ri Marketable stock value not reduced for hypothetical or assumed brokerage costs.

[] Preferred stock liquidation value was not a cap on fair market value (FMV).

[] Estate failed to meet the increased burden of proof required for a contamination refund claim.

[] Tax Court reconfirmed that a minority interest discount (MID) and special use valuation do not mix.

* "Disallowed" agreement increased stock value and marital deduction

In 1992, the Tax Court ruled in Est. of Lauder(63) that a buy-sell agreement was a device to transfer property to the natural objects of the decedent's bounty and would be ignored in determining the estate tax value of transferred stock. in a subsequent decision,(64) the court calculated the stock's value, in part,'by allowing a 40% lack of marketability discount (LOMD).

The corporation had redeemed the stock at the below-FMV buy-sell agreement price, thereby indirectly benefiting the remaining shareholders. The surviving spouse, one of the shareholders, benefited through the increased value of her stock. The IRS contended that no marital deduction should be allowed for the increased value because the transfer was not directly to her. The estate countered that various authorities in the gift tax arena conclude that transfers to corporations are treated as transfers to the shareholders(65); a gift tax marital deduction has been allowed under similar circumstances.(66)

The IRS also asserted that the passed interest was a terminable interest, because the surviving spouse's estate would later be forced to sell the stock at below FMV under the buy-sell agreement. The court disagreed, because the agreement would not be respected for subsequent transfer tax purposes and the surviving spouse would be subject to gift or estate tax on her stock's FMV when transferred. The marital deduction was therefore allowed.

* Valuation discounts determined

The type and magnitude of valuation discounts continued to be a significant point of contention. In Cervin,(67) the decedent owned undivided 50% community property interests in a 657-acre farm and a homestead. The Tax Court noted that it would be difficult to partition the farmland due to its varied soil compositions, layout and limited access to the main road; thus, a discount was appropriate, because a partition would involve substantial legal costs, appraisal fees and delay. However, a fractional interest owner could petition for a forced sale of the homestead. A prospective buyer would require a sizable discount because, under applicable state [Texas] law, he would incur the costs of such sale. The Tax Court thus allowed a 20% discount to the agreed FMV of the decedent's interests.

In Luton,(68) the decedent owned 78% of the stock of an S corporation (A Corporation), which owned a large ranch in California. The ranch land was subject to substantial local use restrictions. The decedent also owned one-third of the stock of a second S corporation (B Corporation), which owned real estate primarily comprised of a duck hunting reserve.

Because A Corporation stock had been held in the family for many years, the Tax Court disallowed valuation reductions for costs of sale or liquidation, finding that no such transaction was contemplated.(69)

Further, based on pre-tax Reform Act of 1986 (TRA) cases,(70) the court declined to allow a discount for capital gain that might be recognized on the corporation's sale of the underlying property. The court noted that it has consistently held that a discount for potential capital gains tax at the corporate level is unwarranted where there is no evidence that (1) a liquidation of the corporation was planned, or (2) the liquidation could not have been accomplished without incurring a capital gains tax at the corporate level. Query why the court apparently assumed that the "hypothetical buyer" would be a qualified S shareholder who could avoid that tax. The IRS indicates that built-in capital gains tax may be relevant in valuation.(71)

The Tax Court allowed a 20% LOMD on A Corporation's stock due to the general illiquidity of the underlying assets and the land-use restrictions. As to the one-third stock interest in B Corporation, the court allowed a 15% LOMD and a 20% lack of control discount (LOCD).

In Simpson,(72) the decedent's wholly owned corporation held one of the largest ranches in Arizona. The IRS and the decedent claimed combined LOMDs and LOCDs of 20% and 30%, respectively. The Tax Court disallowed the LOCD, because the decedent owned all of the corporation's stock. A 30% LOMD was allowed for the size and uniqueness of the ranch.

In Scull,(73) a 5% discount was allowed for a decedent's undivided 65% interest in a contemporary art collection, much of which was sold prior to the filing of the estate tax return. The court approved use of actual sale prices discounted to the date of death. Under an agreement, the decedent and his ex-spouse had held alternating rights to select artworks at agreed values until the ex-spouse had selected works totaling 35% of the collection's agreed value. The court determined that these rights created only minor uncertainties to a potential buyer of the 65% interest, resulting in only a 5% discount.

* Marketable stock value not reduced for underwriting fees and expenses

In Gillespie, III,(74) although a blockage discount was appropriate for a 6.54% stock interest in The Washington Post, hypothetical secondary offering costs for underwriting could not be used to further reduce the estate tax value. The Second Circuit accepted the IRS's position, as expressed in Rev. Rul. 84-30,(75) and concluded that, because such expenses are deductible as administration expenses, they cannot also be considered as a reduction to the stock's value; rather, the value must be based on the price the public would pay to the underwriter, not what the underwriter would pay to the estate. Accordingly, underwriting fees were not considered in determining the blockage discount.

* Liquidation value stated in corporate documents rejected

In Letter Ruling (TAM) 9419001,(76) in 1984, prior to death, the decedent exchanged publicly traded common stock for preferred stock in a closely held investment corporation. The preferred stock contained voting control, a $15 noncumulative dividend per share and $100 per share liquidation value.;-noting simply that the decedent was not required to liquidate the company on his death, the IRS concluded that the stated liquidation value was not a ceiling for estate tax valuation purposes. Interestingly, if the IRS agent on audit were to assert that the relatively high dividend rate added substantial value, that position would be contrary to the IRS's arguments leading to the enactment of Sec. 2701, that noncumulative dividends add little value.

* Estate failed to meet burden of proof on contamination claim

In Necastro,(77) the decedent owned an automobile salvage yard, including underground storage tanks and an area to dump fill material. An adjacent site was under investigation as a possible "superfund" site. The estate tax return reported the property's FMV without reduction for the possible contamination. Subsequently, the executor filed a refund claim, asserting that the property was virtually worthless.

The Tax Court denied the claim. According to the court, the value stated on the Federal estate tax return was an admission by the estate; further, a lower value cannot be substituted without cogent proof that the reported value was erroneous.(78) The Tax Court allowed estimated costs to clean the contaminated soil, remove the storage tanks and conduct ground water studies; however, no reduction was allowed for the costs of more speculative environmental concerns, because the estate could not prove that the contamination occurred before the valuation date or that a potential buyer would have perceived an...