Fall Has Arrived - and Time is Running on the Tax Relief Act of 2010
This Newsletter reviews how Succession Planning involves Valuation Strategies and the use of Family-controlled Entities, such as FLPs, LLCs and S corporations (all pass-through entities). In my last Newsletter dated July 10, 2011, I reported on some recent valuation cases (4 of them), and here we will reprise that report as it relates to Family Wealth Succession Planning.
The Tax Relief Act of 2010 provided but a two-year "fix" and enhanced benefits to taxpayers in the gift, estate and GST transfer tax area - and we are nearing the end of 2011, leaving then only 2012 (a national election year!) to take advantage of the TRA 2010 for our clients. Therefore, not knowing what will come in 2013 (if no additional legislation, we go back to pre-2001 transfer tax law!), estate planners should motivate clients to get the wealth succession plan reviewed, updated and in order. Full utilization of the present $5 million lifetime gift tax exemption per donor, including leveraging the $5 million up to $8 million or more through entity planning, makes good sense. This is especially the case in the ongoing recession - low business and asset values, low interest rates, increasing possibilities of adverse tax legislation in the near term.
Note that full utilization of the $5 million gift exemption can be accomplished by a married couple through the use of irrevocable lifetime QTIP trusts (marital deduction qualifying trusts). Thus, even if 2013 brings back the pre-2001 law, or there is a reduction of the $5 million exemption to $3.5 million (the current Administration proposal), the $5 million is "locked in"!
Valuation and Entities - Entity Reality: Not Understood by the Tax Court?
I reported in the July 10th Newsletter on the case of Estate of Natale Giustina v. Commissioner, T.C. Memo. 2011-141. This was an FLP valuation case in which the decedent died owning a 41%+ interest as a limited partner in the Giustina FLP. The FLP was actively involved in timberlands management, harvesting and timber sales. The trial testimony was clear, and uncontroverted, that the family intended to stay in the timber business for many decades to come.
However, the appraiser testimony indicated that the present value of the expected income stream from the partnership was near $60 million over the long term, while sale of the timberlands and liquidation of the FLP could bring over $150 million, even net of a 40% agreed "market absorption" discount. Since Natale Giustina had a minority interest, and thus could not force sale of the partnership assets and distribution of net proceeds, the estate's appraiser concluded that the "net asset value" (NAV) method should not be used. Yet the IRS appraiser concluded NAV should be weighted with other methods on a 60% weighting! Tax Court Judge Morrison seemed to think that someone would convince enough family members to go with the sale of assets approach that NAV should be weighted 25% and the income methodology conclusion 75% - the result was a much higher net valuation for the estate's non-controlling interest. Refer to Estate of Clyde Wright v. Commissioner, T.C. Memo. 1997-3, in which Judge Swift refused to follow this "possibility" approach.
Then Judge Morrison in Giustina what appears to have been an "off-the-wall" conclusion on discounts - stating that no minority or marketability discounts on the FLP NAV should be allowed as that would involve a "double discount", i.e. the market absorption discount on the timberlands value was already determined! This seems to me to be overlooking the "two-step" approach to value in entity interests - first you value the enterprise or underlying asset value (here the NAV of the timberlands), and then you must value the property interest transferred separately - here that is the 41%+ limited partner interest owned by decedent at death. We will await further developments, i.e. whether the estate will appeal the court's opinion and decision in Giustina.
Somewhat related is an article in the October, 2011 issue of Business Valuation Update, published by BVR (Business Valuation Resources). This article is titled: "Appraisers Seeking Discounts Must Explain Why Families Would 'Destroy Value'" - reporting on the ASA L.A. Chapter's Appraisal Institute IRS Valuation Summit held in Los Angeles last month. Tax Court Judge Mark Holmes asked the question about why families would destroy value by using an FLP or LLC, stating "You had better have a good story to describe why a discount is valid."
Once again it appears a Tax Court Judge doesn't get it! In my view, there are no "discounts", merely downward adjustments to business enterprise or NAV when what is valued is the non-controlling, non-marketable interest in a non-public entity - see the seminal IRS Rev. Rul. 59-60. Certainly, we must have appraisers representing taxpayers who are qualified, experienced and credible, as well as being able to be advocates for their value conclusions, not advocates for the taxpayers who pay them. On the other hand, once a real and significant purpose or purposes can be shown for the use of the entity, the valuation adjustments should be accepted as real. Consider Warren Buffet, and you having an opportunity to contribute $1 million to a new LLC entity he is forming to invest in companies. Certainly, you would accept the restrictions of the LLC operating agreement, which in the end mean you cannot get your money back for a considerable time. The "fair market value" of your interest at the get-go obviously is worth much less than your $1 million in cash just prior to investment - right? We should watch for further developments here as it has become apparent that some Tax Court Judges just do not see why "discounts" are appropriate, i.e. thinking the entity is merely to save some estate tax!
And then we have the recent case of Estate of Clyde W. Turner, Sr. v. Commissioner, T.C. Memo. 2011-09 (August 30, 2011) - The most significant issue dealt with by Tax Court Judge Marvel was whether IRC Sec. 2036(a) applied so as to ignore the FLP holding investment assets, and thus eliminate any valuation discounts. Here is another "bad facts" case, well worth reading (see the opinion by checking www.ustaxcourt.gov). The result was for the IRS, and so the FLP was disregarded, the court finding that the "bona fide sale" exception - accepted in 11 of over 30 prior opinions of the court - did not apply on the Turner facts. By the way, a second issue was whether decedent's direct payments of life insurance premiums on policies owned by a previously established irrevocable life insurance trust qualified for the 2503(b) present interest annual gift tax exclusion due to the lapsing short-term power of withdrawal provision in the trust. The court said "Yes" - the unfetter, unqualified lapsing power of withdrawal, per the Crummey and Cristofani judicial decisions supported this conclusion. This is good news, as I was the principal litigator for the estate in the 1991 Cristofani case!
Fall CPE Opportunities - Valuation, Wealth Succession Planning and More!
1. The 31st Annual Southern California Tax & Estate Planning Forum (10/29-29/11)
This Forum, led for over three decades by Lonnie McGee and his wife, Kimberly Blake, once again hs an outstanding agenda - including the annual 3-hour New Developments presentation by Professor Jeff Pennell. With the TRA 2010 on planners' minds (including for 2010 estates!), several topics deal with effective use of the estate tax opt out election in 2010 estates, as well as with the estate exemption portability provisions and the 2-year $5 million gift and estate exemption.
In addition, there are presentations on asset protection planning, 706/709 compliance planning, employee benefits planning (Natalie Choate, of course), business succession strategies, and more.
The partner with my former law firm in California, John Prokey, Esq., and ASA appraiser Mark Higgins and I will present the topic "Valuation - the Core Concept in Succession Planning: New Cases, New Strategies and Old Pitfalls".
This is the place tax practitioners and planners can get the latest in wealth planning and compliance strategies, and in the beautiful locale of San Diego. Check it out at www.clenet.com.
2. The Family Business and Investments Succession Planning Conference (11/14-18/11)
This theme conference, being presented for the first time by CPE provider Western CPE (www.westerncpe.com), will focus on Family Wealth Succession Planning, using several panel presentations by experts and a total of eight (8) 3-hour in-depth courses covering valuation, family wealth planning with entities, human issues in succession planning, trusts for succession planning, tax standards and avoidance of penalties, 706/709 strategies and compliance, and post-death trust administration and Form 1041 planning.
I am honored to be the conference coordinator for this succession planning conference, which is geared to attract senior CPAs, lawyers and other practitioners who work with families having business and investment wealth.
The conference is set for the beautiful Omni Tucson National Resort in Tucson, Arizona. Check out the Western CPE website for details on topics, speakers and registration costs.
3. Fiore Webcast Presentations.
Finally, this last quarter of 2011, I am presenting several courses on the web, including those on the TRA 2010 specifically, Valuation planning, Using FLPs, LLCs and S Corporations. To check the dates and times for these presentations, check Tax Courses on the following websites: www.CPELink.com and www.CPECredit.com. Any of my readers that might join one or more of these webcasts would be most welcome!
In closing, thank you for reading my Newsletter, and I hope you will check it out again. If you sign up for the automatic email alerts of newly posted Newsletters, you won't miss one.
Owen Fiore "On the Middlefork of the Clearwater River in North Idaho"
