Magazine article The CPA Journal

Qualified Terminable Interest Property (QTIP) Trusts and Valuation Discounts

Magazine article The CPA Journal

Qualified Terminable Interest Property (QTIP) Trusts and Valuation Discounts

Article excerpt

Mathematicians firmly believe that the sum of the parts is always equal to the whole. But, is this necessarily true when valuation discounts are applied to fractional interests transferred by gift or bequest? Many practitioners are now familiar with the concept of valuation discounts when valuing fractional interests, either for gift tax purposes or estate tax purposes. These issues have been discussed at length in various publications and at seminars with reference to the now well-known IRS Rev. Rul. 93-12 and the landmark Bright case in the U.S. Court of Appeals (M. Bright Estate, CAS, 81-2 USTC. S13, 436). Briefly, valuation discounts have been claimed, and are being allowed, due to lack of marketability and for minority interests in various types of entities, such as partnerships, joint ventures, and corporations.

Valuations for both gift tax and estate tax are determined by the fair market value of the asset as of the date of the gift, or the date of death. The often cited definition of fair market values per IRS Regulations Sec.20.2031- l(b) is, "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts." For some time the courts have permitted taxpayers in both estate and gift tax cases to discount full fair market value by a lack of marketability dis count (LOMD), as well as, in appropriate cases, a minority discount (MD). Lack of marketability discounts are usually applied to assets for which there is no ready market, either due to the nature of the asset, or due to some restriction on its transfer or sale by reason of some agreement among various parties, such as a first right of refusal by a co-owner, partner, or costockholder. Minority discounts are usually applied to a fractional interest of less than 50% in a joint venture, partnership, or corporation, which amounts to lack of control, so as to make it unattractive to any potential purchaser willing to bid for such asset or interest, thereby decreasing its value for sale purposes, as well as its gift tax or estate tax value. Of particular importance are these interests which are owned by several members of a family, each member of the family owning only a minority interest, but taken together the family having a controlling interest.

Beginning as early as 1940, the Tax Court has uniformly valued a decedent's stock for estate tax purposes as a minority interest when the decedent himself owned less than 50% of the stock, and despite the fact that control of the corporation was within the decedent's family. While in most cases the IRS will allow both a "LOMD" and an "MD" where the facts warrant such discounts, the IRS in the past has been loathe to allow such discounts where a family in totality does have a controlling interest. In fact, in some cases the IRS has insisted on a "control premium" added to fair market value where control of the asset or entity is of importance in what a willing buyer will pay for an asset or interest. In these cases, the IRS insists that "the whole is worth more than the sum of the parts." Nevertheless, taxpayers on estate tax or gift tax returns have been taking such discounts of anywhere between 10% to 40%, and, if challenged by the IRS, have either settled on a compromise basis or petitioned or appealed to the courts to have such discounts sustained. As a result of several court decisions, in a 1993 ruling, the IRS exhibited a change of attitude in "family control" situations. In reaching this conclusion in Rev. Rul. 93-12, the IRS finally recognized the force and weight of authority of the Estate of the Mary Frances Bright case in the U.S. Court of Appeals for the Fifth Circuit (cited above), as well as the cases of Estate of Lee vs. Commissioner (69 TC 874) which rejected the concept of family attribution and aggregation of minority interests.

The Bright Case

In the 1981 Bright case, a husband and wife together owned 55% of the common stock of Texas Motor Freight Lines, Inc. …

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