Special Dispositive Provisions: Discountable Interests
| Author | Jerold I. Horn |
| Profession | Lawyer |
| Pages | 211-246 |
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The analysis and conclusions in this chapter are subject to change if the regulations that
the IRS has promulgated with respect to Code Section 2704 are enacted as permanent
regulations. The proposed regulations are the subject of severe criticism. Perhaps more
importantly, they are subject to a political climate in which President Trump is attempt
-
ing generally to ban proliferation of regulations. Further, any enactment, even if it were
to occur, might not occur until the passage of years. Purposely, therefore, the analyses
and conclusions in this chapter do not take into account the possible implications of
the proposed regulations.
A person can transfer control of a family business (that is, stock of a corporation or
an interest in a partnership) with, paradoxically, a discount in value for lack of control
and without including any of the discount in any taxable transfer at the level of the gen-
eration of the transferor. The principles apply also to undivided interests in property
(usually real property and tangible personal property) that is not partitionable in fun-
gible portions or of which the whole is more than the sum of fungible parts. Although a
discount for undivided interests also has some aspects that resemble a discount for lack
of marketability, a discount for lack of control and a discount for undivided interests
are functional analogues in important respects. The transfer tax and planning principles
that apply to one tend to apply also to the other.
Despite the similarity, for purposes of valuation discounts, of corporate stock, part-
nership interests, and undivided interests, important distinctions do exist. Whereas,
for example, ownership at death of no more than 50 percent (or, in some cases to some
extent, such larger percentage that is the largest which does not control liquidation)
of the voting stock of a corporation is necessary to produce a lack-of-control discount
for both the voting stock and for any nonvoting stock that the owner also owns, and,
whereas, at least in some jurisdictions, ownership of any general partnership interest (no
matter how small) in a limited partnership tends (at least in the view of this writer) to
undermine a lack-of-control discount for both the general partnership interest and for
any limited partnership interest that the owner also owns, ownership of any undivided
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Special Dispositive Provisions
Discountable Interests
Chapter 8212
interest (no matter how large) in real property tends to justify a discount. Seen from this
perspective, generation of a discount is most difcult with partnership interests (because,
at least in many jurisdictions, ownership of any general partnership interest seems to
preclude it), and is more difcult with voting stock (because ownership of more than
one-half seems to preclude it) than with undivided interests (because only ownership of
100 percent seems to preclude it). One implication is that, at least in many jurisdictions,
a taxpayer who has a choice should avoid ownership of a general partnership interest in
a limited partnership and, instead, should own less than a majority of voting stock in
an S corporation that is the general partner in the partnership.
I. FIR ST SCENARIO
The First Scenario is lifetime planning for a person who possesses control. It is the most
common. Arguably, it also is the most important.
First, consider gifts to any donee. If a gift, per se, does not consist of control, a dis-
count for lack of control reduces the value of the gift for gift tax purposes. Rev. Rul.
93-12, 1993-1 C.B. 202. The discount facilitates the transfer of an increased interest,
representing a greater value of underlying assets, within a given amount of exclusion,
deduction, gift tax, or applicable credit.
The donor can retain control and yet claim a lack-of-control discount for any gift that,
per se, does not consist of control. Further, a gift of the smallest interest that deprives
the donor of control can allow the donor to transfer control without including the value
of control in any taxable transfer at the level of the generation of the donor.
Consider, next, gifts to the spouse of the donor. If a gift to the spouse of the donor
does not represent control, it, too, receives a discount for lack of control. Rev. Rul.
93-12, 1993-1 C.B. 202. Because the gift qualies for the marital deduction, it defers
the payment of tax. Thus, the discount tends to become academic. Again, however,
as in the case of a gift to any donee other than a spouse, a gift of the smallest interest
that deprives the donor of control can allow the donor to transfer control without
including the value of control in any taxable transfer at the level of the generation of
the donor. If the donor were the owner of 100 percent of the stock of a corporation,
the owner during his or her life could give 50 percent to his or her spouse. Upon his
or her death, as explained more fully in the discussion of the Third Scenario at III,
the predeceasing spouse could leave his or her 50 percent to a QTIP-style trust for
the benet of his or her surviving spouse. Without more, according to the theory of
Bonner v. United States, 84 F.3d 196 (5th Cir. 1996), and its progeny, the gross estate
of the surviving spouse would include two noncontrolling interests, each subject to
a discount.
213Special Dispositive Provisions
What type of gift from one spouse to the other is appropriate? An outright gift is
appropriate if the donor is satised about how his or her spouse will manage the gift.
If the donor cannot rely upon the spouse’s management, the donor instead can use a
transfer to a QTIP trust. The donor cannot serve as a trustee with a right to vote. Code
§ 2036(b). The spouse is not an appropriate trustee, because the very purpose of using
the trust is to address the lack of condence of the donor in the management ability of
the spouse. The donor can name as trustee any other person (arguably even someone
who, according to Code Section 673(c), is a related or subordinate party for income tax
purposes) whom the donor does not control, and is not deemed to control, for estate
tax purposes. See Rev. Rul. 95-58, 1995-2 C.B. 191; Code §§ 2036, 2038; Estate of Helen S.
Wall v. Comm’r, 101 T.C. 300; Byrum v. United States, 311 F. Supp. 892 (S.D. Ohio 1970),
If a donor is to use lifetime gifts to relinquish control, the donor must make the gifts
before the donor dies. Additionally, the use of nontaxable gifts for this purpose requires
the donor to make the gifts before his or her spouse dies. Therefore, the donor should
consider making the gifts sooner rather than later.
II. SECOND SCENARIO
The Second Scenario is testamentary planning for a person who possesses control. Often,
it involves a person who has not made sufcient use of lifetime gifts. Taxable transfers
at the death of a person who dies while possessing control are unavailing to create a dis-
count for lack of control. Therefore, if a decedent owns a controlling interest and has
no surviving spouse, the object of transferring control without including the value of
control in the transfer tax base of the decedent is unattainable. The principles of Rev-
enue Ruling 93-12, 1993-1 C.B. 202, apply only to inter vivos transfers. If the gross estate
of a person for estate tax purposes includes control, no discount for lack of control is
available for purposes of calculating the taxable estate of the person, even if the dece
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dent does not give a controlling interest to any one beneciary. Cf. Estate of Chenoweth v.
Comm’r, 88 T.C. 1577 (1987).
A. The Objective
Unless an owner (O) of 100 percent of the stock of a corporation disposes of all of
the stock at his or her death in one or more dispositions that qualify (inherently or
by QTIP election) for the marital deduction and produces a marital deduction exactly
equal to the value at which the stock is included in his or her gross estate, O includes
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