Discount Allowed for Build-In Capital Gains Tax in Valuing Closely Held Stock

Article excerpt

On August 18, 1998, the U.S. Court of Appeals for the Second Circuit, in 1. Eisenberg v. Commissioner (US-CT-APP-2, 98-2 USTC), overturned a Tax Court decision by allowing a discount for built-in capital gains in determining the fair market value of closely held stock for gift tax purposes.

Irene Eisenberg owned all of the stock of a C corporation. The corporation's sole fixed asset was a commercial building, and its only active trade or business was the rental of the building. There were no plans to liquidate, sell, or distribute the building. In 1991, 1992, and 1993, Ms. Eisenberg gifted shares of the corporation to her son and two grandchildren.

IRC section 2501 imposes a gift tax on the transfer of property by gift during the calendar year by any individual. IRC section 2512(a) states that if the gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift. Regulations section 25.2512-1 provides that the value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts.

In determining the value of the gifted shares in each of the years, the taxpayer utilized the net asset value method and took a 25% minority discount. In addition, the value of the stock was reduced by the full amount of the capital gains tax that the taxpayer would have incurred had the corporation liquidated or sold its fixed asset.

The IRS challenged the taxpayer's position regarding the capital gains tax discount. According to the commissioner, the value of the gifts should not have included reductions in the stock's value to account for potential capital gains tax liabilities. …