Discounts for built-in gains.
Prior to 1986, a corporation could liquidate without gain recognition. This rule, known as the General Utilities doctrine, was repealed in 1986. Despite this change, courts still generally refused to allow a discount for taxes payable on liquidation.
A recent Tax Court decision, Estate of Davis, 110 TC 530 (1998), has been deemed "a new inroad in valuation;" it allowed a discount on the value of corporate stock, acknowledging that tax would be incurred on the built-in capital gains that would be recognized if the assets were sold or the corporation liquidated. The appropriateness of the discount was quite apparent, but the court had trouble reconciling it.
The IRS had relied on pre-General Utilities arguments: there should be no discount for the built-in capital gains, because tax planning would have avoided the gain (Piper, 72 TC 1062 (1979)). The Service also relied on prior decisions that denied any reduction for capital gain when there was no liquidation plan or asset sale as of the valuation date (Cruikshank, 9 TC 162 (1947)).
The Davis court found that, when there is no planned liquidation or sale of the corporation's assets as of the valuation date, the full amount of the built-in capital gains tax may not be taken as a discount or adjustment in determining the FMV of the stock in question, even if it is unlikely that the corporation could have avoided any of the built-in gains tax as of the valuation date (e.g., by electing S status). It ruled that a discount or adjustment for some of the built-in capital gains tax should be taken into account in valuing the corporate stock; further, such discount or adjustment should be part of the lack-of-marketability discount (as a buyer would demand). Thus, the court finally recognized that potential capital gains costs affect the valuation of corporate stock.
Davis was not an aberration. On Aug. 18, 1998, the Second Circuit followed its reasoning in Eisenberg, 155 F3d 50. It reversed a summary judgment granted by the Tax Court in favor of the Service and remanded the case to redetermine the amount of the girl tax liability. In Eisenberg, the donor took a series of discounts, then discounted the stock even further for the full amount of the built-in capital gains. The court did not decide how much of a discount would be justified, but it did affirm that, even though no liquidation or sale of the corporation or its assets was planned, an adjustment for potential capital gains tax liabilities should have been taken into account in valuing the stock.
The only issue still awaiting resolution is not whether a discount for built-in gains tax is appropriate, but how much that discount should be. Although an actual liquidation plan is not required to justify a discount for built-in gain, the imminency of such an event may well affect the size of the discount.
While the IRS acquiesced in Eisenberg, the Tax Court has not yet decided whether a discount for built-in gains will be a separate discount or part of the lack-of-marketability discount. Certainly, one of the factors will be whether there is an imminent plan of liquidation or sale.
FROM RANDI A. SCHUSTER, J.D., LL.M., NEW YORK, NY
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|Author:||Schuster, Randi A.|
|Publication:||The Tax Adviser|
|Date:||May 1, 1999|
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