Estimated reading time: 3 minutes

VRC professionals recently immersed themselves in a week-long educational experience at the 58^th Annual Heckerling Institute on Estate Planning. Renowned as the foremost gathering for estate planning teams nationwide, Heckerling offered many insights. Here, we distill key highlights, discussions, and resources from our experience, tailored from a valuation professional’s perspective. While we aim to provide concise summaries of these complex issues, our readers are encouraged to explore these topics further with the author.

Major Developments

Estate of Cecil v. Commissioner, T.C. Memo. 2023-24 (February 28, 2023)

• The case focused on tax affecting a pass-through entity and the appropriate valuation methodology of a non-controlling interest.
• The Tax Court accepted tax affecting the S-corporation in question due to the facts of the case (both the IRS expert and taxpayer’s expert tax affected). The judge was hesitant to adopt a tax-affecting analysis by stating the following: “Given the unique setting at hand, we are not necessarily holding that tax affecting is always, or even more often than not, a proper consideration for valuing an S corporation.”
• The Tax Court rejected using the asset approach for a non-controlling interest in an operating company.

Connelly v. United States, 131 AFTR 2d 2023-1902 (8^th Cir. June 2, 2023), aff’g 128 AFTR 2d 2021-5955 (E.D. Mo. 2021), petition for cert. filed (U.S. No. 23-146, August 16, 2023)

• The Court rejected the taxpayer’s contention that corporate-owned life insurance proceeds to fund a buy-sell agreement should not be included in determining the estate tax value of shares.
• The buy-sell agreement did not satisfy Section 2703(b) safe harbor requirements to fix estate tax value.

Current Issues in Estate and Gift Tax Audits and Litigation

The presenter recommends anticipating a dispute at the estate planning stage. The IRS is staffing up from the $80 billion allocated by the Inflation Reduction Act of 2022. Staffing in the gift and estate tax function has resulted in many new estate and gift tax examining agents and appeals officers. Overall, the sentiment is that a planner should expect to see more audits in the years ahead.

A few popular valuation-related audit topics covered include:

Valuation Discounts
Case law regarding accepted valuation discounts are disperse. Many accepted discounts depend on the expert’s qualifications and the valuation report. Quality appraisals are paramount in the planning phase.

Rejection of the Asset Approach
When valuing a non-controlling interest in an operating company (see Estate of Cecil v. Commissioner noted above).

Unrealized Built-In Capital Gains
Courts have accepted unrealized built-in capital gains discounts on appreciated capital held in a C corporation. While facts and circumstances between cases differ, Courts have generally accepted dollar-for-dollar discounts or present valued discounts. Cases noted in the materials include:

• Estate of Davis v. Commissioner, 110 T.C. 530 (1998)
• Eisenberg v. Commissioner, 155 F. 3d 50 (2d Cir. 1998)
• Estate of Jameson v. Commissioner, 77 T.C.M (CCH) 1383 (1999)
• Estate of Dunn v. Commissioner, 301 F. 3d 339 (5^th 2002)
• Estate of Jelke v. Commissioner, 507 F. 3d 1317 (11^th 2007)
• Estate of Litchfield v. Commissioner, T.C. Memo. 2009-21 (January 29, 2009)
• Estate of Jensen v. Commissioner, T.C. Memo. 2010-182 (August 10, 2010)
• Estate of Richmond v. Commissioner, T.C. Memo 2014-26 (February 11, 2014)

Tax Affecting Pass-Through Entities

Recent court cases “highlight the need for the expert to explain in detail why tax affecting is appropriate and to determine the benefit, if any, of flow through status.”

A wealth of publicly available research demonstrates that owner-level taxes affect the value of an equity interest, directly referencing Nancy Fannon and Keith Sellers’ Taxes and Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle.

In several cases, the IRS has taken the position that a flow-through entity should not be tax affected in determining the value of an equity interest as the entity does not pay entity-level taxes. However, the Tax Court cases that address tax affecting do not prohibit tax affecting cash flows of a pass-through entity. The Tax Court cases that addressed tax affecting before the Jones case (2019) were Tax Court Memorandum cases authored by three judges who are no longer sitting. As such, the tax affecting issue has not been decided as a matter of law. This view is shared in Judge Pugh’s opinion in Estate of Jones v. Commissioner, T.C. Memo 2019-101 (August 26, 2019) as the taxpayer’s expert’s tax affecting analysis was deemed more “convincing.” In Estate of Jackson v. Commissioner, T.C. Memo 2021-48, the judge declined to tax-affect cash flows for a number of assets held within pass-through entities as the estate’s experts did not “(i) persuade the Court that a taxpaying entity would be the likely hypothetical buyer of the assets at issue, (2) did not consider the tax detriments and benefits of pass-through status, and (3) disagreed on the appropriate tax rate.”