A New Year - and the Impact of the American Taxpayer Relief Act of 2012 (ATRA 2012) is Huge!
My last Newsletter, 9/29/13, was titled "Succession Planning 101 - A New and Better Era!" Indeed, it is clear that, while the "permanent" (until changed by legislation) high transfer tax exemptions - $5.34 million per person in 2014 - and the lower 40% flat gift, estate and GST tax rate, means 99%+ of estates will have no Federal estate tax, there is much to do in estate and succession planning. And now income tax planning, especially as to step-up in tax basis at death and shifting income tax to younger generations, is more important than ever. The non-tax reasons for succession planning remain and are in the spotlight now.
Even though it is unlikely much in the way of tax legislation will be passed at the Federal level this year (especially given the mid-term elections in the Fall of 2014), the year 2015 may well see significant tax legislation, even as to the Federal transfer tax (see below the outline of Fiscal Year 2014 Administration Revenue Proposals).
This Newsletter includes reviewing recent cases in the Valuation area - The Tax Court makes clear its intention to be active in valuation cases, often to make its own determination of value.
Also, on the CPE front, I continue to work productively with Western CPE (see www. westerncpe.com) on its webcasting, self study and resort conferences. I have two new webcast courses to be added to my present three webcast courses in estate and succession planning. The two new courses are "Estate and Succession Planning for the 99%" and "Winning the Valuation Game" - each a 3-CPE course to be filmed in May and offered beginning in June or July. In addition, for Western CPE, Paul Larson, CEO, and I are working on the 4th Annual Western CPE Family Wealth & Business Succession Planning Conference, to be presented November 10-12, 2014, inclusive, in Tucson, AZ - More will be in the Western CPE resort and precision conference lineup online soon.
Administration Revenue Proposals - F/Y 2014 (10/1/13-9/30/14).
As detailed in the Treasury's "Green Book", General Explanations of the Administration's Fiscal Year 2014 Revenue Proposals, there are a number of proposals related to the Federal transfer tax (gift, estate and GST taxes) -
First, it is proposed that transfer tax exemptions and rates will revert back to the 2009 levels - $3.5 million exemption per person for estate and GST taxes, and only $1 million for gift tax exemption - watch this proposal But probably all is well, in that the proposal itself would be effective only beginning in 2018 (when then former President Obama is busily working on his Presidential Library).
Second, and adversely affecting the now somewhat popular use of Grantor Trusts in estate planning, such as the IDIT (Installment sale to an intentionaly defective grantor trust), is that where there is a "sale, exchange or comparable transaction" (whatever that means!) involving a grantor trust (per IRC Secs. 671-679) there would be an estate tax (payable by the trust!) in the estate of the grantor on death, or a gift tax when the trusts ceases to be a grantor trust. However, contrary to the prior year's revenue proposal package, this proposal excludes irrevocable life insurance trusts, such as where a grantor trust due to IRC Sec. 677(a)(3), allowing use of trust income to pay life insurance premiums. Also, GRATs and QPRTs under Sec. 2702 are excluded as well.
Third, additional restrictions on GRATs are proposed, including requiring a minimum term of 10 years, a maximum term of the annuitant's life expectancy plus 10 years, minimum taxable gift requirement, and prohibition of "front-loaded" GRATs.
Finally, there is more (not including any valuation discount restrictions, since most probably Treasury soon will issue Prop. Regs. under IRC Sec. 2704, regarding lapsing voting and liquidation rights retroactive back to 1990!), as follows:
1. Sec. 101 - "buyers of insurance policies" will be subject to the "transfer for value" exception to exclusing life insurance proceeds for income tax purposes.
2. As to the unlimited gift tax exclusions for direct payment of tuition and medical expenses, the proposal is to limit this exclusion to "living donors" payments (so would not apply to trust distributions).
3. The often included proposal for "consistency" in income tax basis reporting again is presented, namely, that FMV reported on the 706 estate tax return must be followed later by an estate beneficiary in reporting step-up in income tax basis for income tax purposes.
4. Limiting the term of a dynasty trust for purposes of the GST exemption to 90 years.
5. Extension of the 10 year estate tax lien, per IRC Sec. 6324(a)(1), to the full Sec. 6166 estate tax installment payment provision of 14 years, 9 months.
6. Restrictions on deductions and harmonizing the rules for charitable contributions of conservation easements and easements for historic preservation.
The U.S. Tax Court Once Again Confirms Its Role in Valuation.
1. First of all, on February 11, 2014, Tax Court Judge Gustafson released his opinion in Estate of Helen P. Richmond v. Comm'r, T.C. Memo. 2014-26 (see the full opinion at www.ustaxcourt.gov) - stating therein "Because valuation involves an approximation, the figure at which we arrive need not be directly traceable to specific testimony if it is within therage of values that may be properly derived from consideration of all the evidence." By reason of the hypothetical party FMV tax standard of value, expert testimony usually forms the principal support for either the taxpayer or the IRS valuation position in litigation. And the U.S. Supreme Court made clear, in Daubert v. Merrell Dow Pharm., Inc., 509 U.S.579 (1993), that the Federal trial courts (including the Tax Court with its "bench trials" - one judge, no jury) are the "gatekeepers" of the credibility, relevance and reliability of expert testimony of all types.
At issue in Richmond was the estate FMV of decedent's 23.44% stock interest in a C corporation owning dividend paying marketable securities. Since the C corporation ("PHC") was an IRC Sec. 541 personal holding company, regular, substantial dividend distributions to shareholders were made to avoid the personal holding company penalty tax. The issues involved here were (i) valuation methodology, i.e. income method used by taxpayer's trial expert versus a net asset value (NAV) method as used by the IRS appraiser at trial, (ii) the existence and extent of discounts for potential built-in capital gains at the corporate level, as well as lack of control and lack of marketability discounts, and (iii) whether the IRS-proposed 20% substantial understatement of valuation penalty should be upheld.
This 51-page opinion is an excellent review of how the Tax Court views valuation in general, and deals specifically with valuation methodology disputes and disagreements over discounts. At the end of the day, the court determined the easily valued marketable securities portfolio of PHC made the NAV methodology appropriate for use as opposed to the "dividend model", an income approach. Then launching into discounts, Judge Gustafson criticized the 100% discount for potential built-in gain, and settled on the IRS expert's proposed discount equivalent to 43% of the built-in gain, involving projection of future appreciation in the securities and discount back to present value - of course there remains a dispute in the appellate courts as to the right approach, so tune in for a possible appeal here to the 3rd Circuit.
Then on other discounts, the court determined a 7.75% discount for lack of control (near the 8% per the estate appraiser), and a 32.1% marketability discount, the mid-point between the estate appraiser's high end discount and the IRS appraiser's low end discount.
Finally, as to the valuation penalty,first note the court's overall valuation conclusion was $6.5 million, as compared to the IRS trial proposed value of $7.3 million and the estate's proposed value of $5 million - each of which were about $2 million down and up, respectively, from initial positions! But the statute regarding penalties here, IRC Sec. 6662(g)(1), requires the comparison to be between the estate's 706-reported value, $3.1 million, and the finally determined (by the court) value. Since the 706 reporting was based on a CPA's draft report, the CPA not being a qualified appraiser, etc., and there was no explanation for the large difference in the trial position supported by a qualified appraiser, and one of the executor's of the estate himself was a CPA, the court concluded the penalty applied here. This obviously is a warning as to the importance of proper and complete appraisal work when the transfer, gift or estate, is reported!
2. Another case awhile back is instructive regarding the premises or assumptions of value, here whether an FLP-based valuation discount is grounded in there being an FLP entity for tax purposes per local law and the FLP agreement. See Estate of Lois Lockett v. Comm'r, T.C. Memo. 2012-143. An Arizona case, due to Mrs. Lockett's termination of the irrevocable trust (established by her husband on his death), there ended up being only 1 "partner" at the date of her death - therefore, no AZ FLP per State law and the partnership agreement itself. Thus, the court disallowed the entire claimed 50% estate tax discount!
3. Finally, again underscoring the Tax Court's gatekeeper role in valuation, see Estate of Diane Tanenblatt v. Comm'r, T.C. Memo. 2013-263.Here we find an LLC interest case heard by Tax Court Judge Halpern, a "regular" now on valuation cases in this court. But the estate's counsel not folloowing the Tax Court's Rules of Practice and Procedure, the Federal Rules of Evidence or even plain common sense, proved to be a tax disaster for the estate. When the case ended up in a dispute between IRS and the taxpayer, a new appraiser was hired by the estate and came in with a much lower valuation position than was used in the 706. But a fee dispute between the new appraiser and the estate resulted in that appraiser refusing to testify at trial. Yet, in spite of the referenced Tax Court Rula and the FRE, counsel to the estate attempted to "bootstrap" into evidence the new appraisal. Judge Halpern patiently went through all the rules, found that the estate had no appraisal evidence at trial, and found for IRS. So following the rules of procedure, admissibility of evidence, etc. is very important!
Well, I sincerely hope this Newsletter is of interest to those reading it, and welcome any comments anyone may have as we continue to proceed with estate and succession planning during this year 2014.
Regards to all! Owen Fiore