Estate and Gift Taxation

Thursday, July 22, 2010

Estate Tax Update

On June 17, 2010, the U.S. House of Representatives passed H.R. 5297, the Small Business Jobs and Credit Act of 2010 (commonly referred to as the "Small Business Jobs Bill").

In the last few weeks, since H.R. 5297 was passed, Senate Minority Whip Jon Kyl (R-Arizona) and Senator Blanche L. Lincoln (D-Arkansas) have been working on a plan concerning the future of the estate tax.  Together they have advanced a proposal requiring the Senate Finance Committee to amend H.R. 5297 so as to permanently set the federal estate tax rate at thirty-five percent (35%) and raise the estate tax exemption amount to five million dollars ($5,000,000), the exemption level to be phased in over a 10-year period and indexed for inflation.

The Kyl-Lincoln proposal would also provide for a "stepped-up" cost basis for inherited assets, as existed in prior tax years, and would instruct the Senate Finance Committee to offset the difference in revenue loss resulting from their proposal as compared to the Obama administration's proposal. [The administration has proposed a 45% estate tax rate coupled with a $3.5 million exemption amount.]

Yesterday, July 20, 2010, the U.S. Senate prepared to resume consideration of H.R. 5297, with the goal of completing work on the Senate version by the end of this week. However, Senate Majority Leader Harry Reid (D-Nevada) is expected to disallow most amendments to the House bill, specifically including the estate tax proposal of Senators Kyl and Lincoln. Senator Kyl told reporters yesterday that, whereas Senator Reid did not want to address any estate tax issues at this time, he (Kyl) and Senator Lincoln were looking at other options for moving their proposal forward. Stay tuned.

INQUIRIES

For additional information please contact the writer, Keith Codron, toll-free, at (800) 497-0864, or via email at keith@octrustlawyer.com.

Mr. Codron, whose office is located in Orange County, California, welcomes your comments and questions.

 

Sunday, April 18, 2010

Valuation Discounts for Gifts of Limited Partnership Interests Reduced

SUMMARY
The U.S. Court of Appeals for the Eighth Circuit has affirmed a decision of the U.S. Tax Court in sharply reducing valuation discounts claimed by a married couple with respect to the transfer of limited partnership (LP) interests gifted to their daughters. Holman v. Commissioner (8th Cir. 4/7/2010), 2010-1 USTC ¶60,592, aff'g 130 TC 170. The 8th Circuit agreed with the Tax Court's holding that, in calculating the value of the gifted LP interests, only small discounts were allowable for lack of control and lack of marketability, even though the limited partnership agreement contained significant limitations on the power of the limited partners to manage the LP or to transfer their interests, including a restrictive buy-sell provision permitting the general partners (parents) to redistribute LP interests if an impermissible transfer were to be made.

FACTS

Taxpayers, Thomas H. Holman, Jr. and Kim Holman, owned a large number of shares of common stock in Dell, Inc., a publicly traded corporation ("Dell"), this as a result of Tom's having been an employee of Dell for many years. Tom and Kim created an LP and funded it with Dell stock. Thereafter, in 1999, 2000 and 2001, the couple gifted minority interests in the LP to their daughters, as limited partners, retaining management control over the entity as general partners.

In filing their gift tax returns for the years in question, the couple discounted the value of the transferred LP interests by 49%, claiming lack-of-marketability and minority-interest adjustments based on the restrictive provisions set forth in the LP agreement, including the transfer restriction, and asserting that such restrictions would depress the value of the LP interests relative to the value of the underlying assets of the LP, the Dell stock. In doing so, taxpayers claimed a value for the gifted interests which was substantially below the market value of the underlying Dell stock.

On audit, IRS challenged taxpayers' gift tax returns for the years in question. IRS characterized the intrafamily transfers as gifts of Dell stock rather than as gifts of LP interests, and disregarded the LP agreement's transfer restrictions for valuation purposes based on §2703 of the Internal Revenue Code. IRS conceded that lack-of-marketability and minority-interest discounts were applicable, but argued that the overall discount should be much smaller than that claimed by taxpayers: 28% relative to the then-prevailing market price of Dell stock.

TAX COURT DECISION
The Tax Court held that the gifts were indeed gifts of LP interests, not of Dell stock, and that IRS had correctly applied Tax Code §2703 in disregarding the LP agreement's transfer restrictions. However, the Tax Court applied much smaller lack-of-marketability and minority-interest discounts than those claimed by taxpayers, noting that the LP held only highly liquid, easy-to-value assets and that the LP agreement contained a consensual dissolution provision.  As a result, the Tax Court accepted lack-of-marketability valuation discounts for each of the years in question of just 12.5%, and minority-interest valuation discounts of just 4.63% to 14.34% (i.e., discounts that were even lower than those proposed by IRS). Taxpayers' stated purposes in creating the structure, to wit, estate planning, tax reduction, wealth transference, spendthrift protection and money management education, were held not to be bona fide business purposes for the transfer restrictions provided for in the LP agreement. The Court of Appeals took notice of the fact that the Tax Court, when it determined the appropriate discount for the LP interests, had considered what a rational economic actor would deem appropriate and had not ascribed personal or noneconomic motivations to the hypothetical purchaser; the Tax Court did not base its determination of the valuation discount on what might be acceptable to a family member.

INQUIRIES
For additional information please contact the writer, Keith Codron, toll-free, at (800) 497-0864, or via email at keith@octrustlawyer.com. Mr. Codron welcomes your inquiries.