Tax Law and Business Organization Strategy

Eleventh Circuit Agrees with Fifth that Corporate Stock Values at Death Must Reflect a Reduction Equal to the Corporation's Full Built-In Capital Gain Tax Liability

The Eleventh Circuit recently held that in determining the value of a decedent's holding company stock for estate tax purposes, the company's value is reduced by the entire built-in capital gain tax liability as of the date of death. (Estate of Frazier Jelke III v. Comm’r) The decision puts the Eleventh Circuit in agreement with the Fifth Circuit. We now have two Circuit Courts disagreeing with the Tax Court and the IRS, which argue a full discount should only be allowed if there is evidence that a purchaser would liquidate the corporation.

Allowing a discount for the full amount of the tax that would be incurred on recognition of all built-in gains, I think, better reflects reality. In my experience, a purchaser of stock always negotiates for a reduction in purchase price equal to the full amount of the tax on the built-in gains. Hopefully, if this issue goes to the Supreme Court, as it may due to the difference of opinion among the Circuit Courts, the Supreme Court will follow the realities of the business world in valuing stock in a corporation and follow the Fifth and Eleventh Circuits.

The Eleventh Circuit relied on the Fifth Circuit's decision in Dunn, Beatrice Ellen Jones Est v. Comm’r. In Dunn, the Fifth Circuit allowed a reduction equal to the 34% tax rate that would be imposed on the recognition of the corporation’s assets' built-in capital gains. The Fifth Circuit reasoned that the hypothetical willing buyer of the decedent's block of stock would demand a reduction in price for the built-in gains tax liability of the corporation's assets at essentially 100 cents on the dollar, regardless of the purchaser’s subjective desires or intentions regarding the use or disposition of the assets.

The Eleventh Circuit said that, under the Fifth Circuit's approach, the estate tax owed is calculated based upon a “snap shot of valuation” frozen on the date of Jelke's death, taking into account only those facts known on that date. The Eleventh Circuit said it is more logical and appropriate to value the corporate shares on the date of death based upon an assumption that a liquidation has occurred, without resort to present values or prophesies. It reasoned that such an approach eliminates the crystal ball and the coin flip, and provides certainty and finality to an already vague and shadowy undertaking.

The Eleventh Circuit stressed that the dollar-for-dollar approach also bypasses the unnecessary expenditure of judicial resources being used to wade through a myriad of divergent expert witness testimony, based upon subjective conjecture, and divergent opinions. It has the virtue of simplicity and its methodology provides a practical and theoretically sound foundation as to how to address the discount issue.

The Eleventh Circuit therefore allowed a dollar-for-dollar discount for contingent capital gains taxes in valuing the corporate stock owned by the taxpayer at death.

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