Estate Court Cases Highlight Importance of Valuation

The outcome of a few recent estate court cases has put a renewed emphasis on the importance of obtaining an objective valuation, and having an expert substantiate the valuation.

ESTATE OF DIANE TANENBLATT

In the Estate of Diane Tanenblatt v. Commissioner, Tanenblatt, who passed away in 2007, had owned a 16.67% membership interest in an LLC which had been transferred into her trust. The principal holding in the LLC was a commercial building in New York City. The estate was valued at $1,788,000 at the time of Tanenblatt’s death. However, the appraisal obtained by the IRS showed a value of $2,475,883. The IRS also hired a second appraiser who valued the estate at $2,303,000. The estate in turn engaged a second appraiser to provide a value of the estate. This time the estate was valued at $1,037,796. The second appraiser though would not testify at the trial due to a dispute over the fee so the estate had to use the original appraisal.

While the first appraisal obtained by the estate and the two appraisals obtained by the IRS started with the same net asset value (NAV), each used different discounts for lack of control and lack of marketability. The first estate appraisal used a 20% lack of control discount, while the two IRS appraisals used a 10% discount. The difference in the lack of control discount was due to varying opinions on the type of interest that Diane Tanenblatt owned. The appraisal obtained by the estate considered the interest a “non-membership,” while the IRS considered it a membership interest. A membership interest is more valuable than an assignee or non-member interest. In the end, the Court agreed with the IRS’ assessment that the subject interest was a member’s interest because at the time of the interest transfer, Tanenblatt was a member. Prior to her death, Tanenblatt had transferred the interest into a trust. In accordance with IRC Section 2038 pertaining to revocable transfers, the value of a gross estate should include the value of all property:

(a) (1) To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3 year period ending on the date of the decedent’s death.

It is important to note that if the expert who provided the second appraisal for the estate would have been in court to testify, the outcome in this case may have been different. Under Tax Court Rule 143 Evidence (c) Ex Parte Statements, “Ex parte affidavits or declarations, statements in briefs and unadmitted allegations in pleadings do not constitute evidence.”

Therefore, though the Tanenblatt estate had an expert report with a new appraisal, the evidence was excluded from evidence because it was not accompanied by the expert’s testimony. The Court accepted the discounts used by the IRS’ expert and ruled that the value of the interest should be $2,303,000.

ESTATE OF HELEN P. RICHMOND

The Estate of Helen P. Richmond, et al v. Commissioner involved a closely held company. An increasing number of cases involving closely held or family owned companies are ending up in court. Unlike a public company, where the market dictates the price, determining the value for estates involving closely held companies can be challenging and is often a point of contention between the estate and the IRS.

At the time of her death in 2005, Helen Richmond owned a 23.55% interest in a family-owned personal holding company. The holding company owns publicly traded securities. On the estate tax return (Form 706), the LLC interest was valued at $3,149,767. However, the accounting firm that provided the valuation did not have the proper certifications and the report provided by the firm was not signed.

The IRS valued the interest at $9,223,658. In addition, the IRS charged a 40% gross valuation misstatement penalty. Depending on the severity of the misstatement, the IRS will impose a 20-40% penalty where underpayment of tax is attributable to a substantial tax valuation understatement.

As in the Tanenblatt case, the estate and the Court disagreed on discounts. The estate used a 35.6% lack of marketability discount while the IRS used a 21% lack of marketability discount. In the end, the Court decided to use a discount of 32.1%, a median of the data range (26.4% to 35.6%) used by the estate and Commissioner. For the lack of control discount, the estate’s expert used an 8% discount while the IRS expert used a 6% discount. The Court held that a median lack of control discount of 7.75% was appropriate. A discount was also applied for built-in capital gains; the estate’s expert applied a discount of 100% and the IRS expert applied a discount of 15%. The Court agreed with the Commissioner’s amount for the discount.

The Court concluded that the value of the subject interest should be $6,503,804. In addition, the Court upheld the IRS’ valuation understatement penalty but reduced it to 20% because it ruled that the uncertified, unsigned valuation submitted initially by the accountant contributed to the initial low valuation on the estate tax return. In this case, convincing expert testimony resulted in the penalty being lowered. The best defense against an underpayment penalty is an independent valuation from a certified appraiser. For more information on valuations for estate and gifting purposes, contact your VRC representative.