Reduced value for gift and estate taxes.

Potential buyers will generally pay more for individual assets than for a corporation's stock. A buyer does this to obtain a higher tax basis for the assets than the corporation had and to avoid hidden liabilities. If the acquired company sells the assets, however, it will owe corporate income tax on any gain. On the other hand, if the shareholders sell the stock, it will owe less tax, but the basis of the assets carries over to the buyer.

Despite this reality, until recently the IRS and the courts had never allowed a reduction in the value of corporate stock for taxes due on an asset sale or corporate liquidation. Two recent cases have allowed such a discount for the first time.

Courts Allow Discounts

In Estate of Artemus Davis, 110 TC 530 (1998), Davis (one of the founders of the Winn-Dixie grocery chain) created a holding company to own some of his publicly traded Winn-Dixie shares and other assets. He did this many years before the transaction in question.

In 1992, Davis gave nearly 26% interests in the holding company to each of his two sons. At that time, the holding company owned $70 million of Winn-Dixie stock and $10 million of other assets.

Davis claimed substantial discounts on the gift tax returns he filed to report the transfers. The discounts were for lack of marketability and minority interest, as well as for the corporate taxes due if the Winn-Dixie stock were to be sold. All of these discounts reduced the value by more than 60% when compared to the value of the holding company's assets.

The Service challenged this valuation, and assessed additional gift taxes of more than $5.2 million. Davis died in 1995; his estate continued to fight the Service over the valuation.

The Tax Court, after considering opinions from three appraisers (hired by the estate and the IRS), held that a discount for taxes was appropriate.

In 1986, Congress had changed the tax law, eliminating the General Utilities doctrine (a way for corporations to avoid tax on asset sales as part of a liquidation). This ability to avoid corporate tax was the primary reason courts had not allowed discounts in the past. The Tax Court saw no way the holding company could avoid the taxes, so it allowed a discount, albeit less than the estate sought. Overall, the court allowed discounts totaling 50% of the assets' value.

In Irene Eisenberg, 155 F3d 50 (1998), vacating TC Memo 1997-483, the Second Circuit concluded that a similar discount for taxes was appropriate in valuing stock in a holding company. In this case, the corporation owned real estate that it rented to third parties.

Ammunition for Taxpayers

In each of these cases, the courts allowed the discounts even though the corporate assets consisted of marketable securities and real estate. In dealing with family limited partnerships, the Service has argued that no discounts for any reason were appropriate when the partnership assets were largely marketable securities. Davis and Eisenberg should make this position more difficult for the IRS to sustain. While the Service may appeal Davis, and Eisenberg is awaiting a new trial in the Tax Court to determine the appropriate discount, the decisions should provide valuable ammunition in dealing with the IRS on these issues.

In light of the decisions, if a taxpayer is considering making gifts of stock in a closely held C corporation, the appraiser should take the taxes into account. This can significantly lower the value of the gift.

FROM HARVEY BERGER, CPA, WASHINGTON, DC