The CPA Journal

Estate Planning for Minority Interests

By Sherry Reisch, CPA, Marks, Paneth & Shron LLP

An interesting court case presents creative estate planning opportunities: Bonner [Estate of Louis F. Bonner v. United States of America, 84 F.3d 196, 96-2 USTC (CCH) para. 60,237 (5th Cir. 1996)] addresses discounts with respect to undivided fractional interests held partly outright and partly through a qualified terminable interest property trust (QTIP).

Historically, the IRS’s position has been that interests held by different family members must be aggregated to determine whether a controlling interest exists for gift and estate tax purposes. If so, a valuation discount would be disallowed. The one exception to this position was when family members were in discord. The IRS has routinely been defeated in the courts on this issue, however, so it has taken the position that a valuation discount is not disallowed solely because a transferred interest, when combined with other interests held by family members, is part of a controlling interest. Nevertheless, the IRS continues to question the size of any discount claimed.

The IRS has traditionally taken the position that when interests in properties, stocks, or partnerships are held in a QTIP or other revocable trust and the trust beneficiary owns similar interests in her own name, the two interests should be aggregated when valued. The aggregation of these fractional undivided interests would preempt the use of a valuation discount that would otherwise be available if the interests were valued separately. The Bonner estate, however, did not aggregate the fractional undivided interests in the properties that were held in a QTIP with the interests held individually by Bonner, who was also the QTIP beneficiary.

Background

Bonner’s estate was comprised of a fee simple 62.5% undivided interest in a ranch in Texas, a fee simple 50% undivided interest in real property in New Mexico, and a fee simple 50% undivided interest in a boat. Bonner’s wife, who predeceased him, had established a QTIP through her will that included the remaining 37.5% interest in the ranch, 50% interest in the New Mexico real property, and 50% interest in the boat. The undivided interests held by the trust along with the undivided interests held outright by Bonner were all included in his taxable estate. The estate sought to claim a refund for the taxes paid on these properties citing that they were, in fact, fractional undivided interests. It found relief: Bonner’s estate was entitled to apply a fractional interest discount in valuing the decedent’s undivided interests in these properties.

The QTIP created under the will of Bonner’s wife satisfied the test for qualified terminable interest property. These assets passed through her estate as a bequest for the trust and were part of the marital deduction. Upon Bonner’s death, these undivided interests held by the QTIP were taxable to his estate.

The estate claimed that the interests of the QTIP, along with the interests that the decedent held outright in these three properties, should not be aggregated for estate valuation purposes. The estate took this position because neither the decedent, who had only a lifetime interest in the trust, nor his estate had any control over the ultimate disposition of the QTIP assets. The estate argued that it was not required to aggregate the QTIP assets with other assets simply because they had passed to the estate. Family attribution did not control the value of the assets; therefore, Bonner’s interest was not 100% but, instead, the fractional interests he held in each of the three properties outright at his death.

A variety of techniques are available to aid in valuing certain assets for estate tax purposes. Valuation discounts allow for a decreased valuation of an ownership interest due to a lack of majority control over the operations of the business by the minority owner, a lack of marketability, fractional interests, or the impact of losing a key individual. Valuation techniques are not optional and must be applied by both the IRS and the taxpayer when determining the fair market value of property. Also inherent in the determination of value is what a willing buyer would pay a willing seller for the property. The discount is an acknowledgement of the restrictions on the sale or transfer of property when more than one individual or entity holds undivided fractional interests. The willing seller is not the estate itself but a hypothetical seller. Therefore, family attribution, which rests upon the seller being the executor, cannot control the value of the asset.

As part of the summary judgment submitted by the estate, the appraisal of Bonner’s 62.5% interest in the ranch included a 45% discount because it was a fractional undivided interest. The New Mexico property and the boat were also discounted on the estate’s tax return.

A Break from Tradition

The importance of Bonner is that it goes against the traditional position taken by the IRS, namely, that all interests in a common entity should be combined. The Bonner estate was not required to aggregate its fractional undivided interests with those held in the QTIP because it was able to prove lack of family attribution over these interests. This judgment opens the door for valuation discounts of fractional undivided interests, even if their sum reaches 100%.

The valuation of interests in property for federal estate tax purposes is a requirement. The use of fractional interest discounts in valuing fractional undivided interests has been consistently upheld in the courts for situations such as the Bonner estate, particularly where the sum of all fractional interests in property are less than the whole. The discount allowed in Bonner affirms the business reality when more than one individual or entity holds an undivided fractional interest. Because Bonner’s estate did not hold any control over the interests in the three properties held in the QTIP, the assets were entitled to be valued independently and were not required to be aggregated into one whole.

Editors:
Lawrence M. Lipoff, CPA
Deloitte & Touche LLP

Susan R. Schoenfeld, JD, LLM, CPA
Bessemer Trust Company, N.A.

Contributing Editors:
:Jerome Landau, CPA

Debra M. Simon, MST, CPA
The Videre Group, LLP

Richard H. Sonet, JD, CPA
Marks Paneth & Shron LLP

Peter Brizard, CPA

Ellen G. Gordon, CPA
Margolin Winer & Evens LLP

Jeffrey S. Gold, CPA
Joseph R. Beyda & Company P.C.

Harriet B. Salupsky, CPA
Weinick Sanders Leventhal & Company LLP

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