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IRA valued without discount for anticipated tax liability.

A had two IRAs at the time of her death. Under the trust agreements, the IRAs were not transferable; however, they both allowed the underlying marketable securities to be sold. On Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, A's estate (E) reduced the net asset value of the IRAs by 21% and 22.5%, to reflect the anticipated income tax liability from distribution of its assets to the beneficiaries.

Discount for Tax Liability

E contends that the application of the willing buyer-willing seller test mandates a reduction in the fair market value (FMV) of the IRAs to reflect the tax liability associated with their distribution. In support, E cites case law that allows a reduction in value of an estate's assets for costs necessary to render the assets marketable or that have otherwise considered the tax effect of a disposition of the assets in other contexts.

E contends that nontransferable IRAs are similar to (1) unassignable lottery payments, (2) stock in a closely held corporation, (3) stock that is subject to resale restrictions, (4) contaminated land and (5) land that needs to be rezoned to reflect the highest and best use. The main problem with this argument is that E is comparing situations in which a reduction in value is appropriate because a willing buyer would have to assume any burden associated with the property--paying taxes, zoning costs, lack of control, lack of marketability or resale restrictions. In this case, however, a willing buyer would be obtaining the securities free and clear of any burden.

Further, the distribution of the IRAs is not a prerequisite to selling the securities. Any tax liability that the beneficiary would pay on the distribution of the IRAs would not be passed to a willing buyer, because the buyer would not purchase the IRAs as an entity due to the transferability restrictions. Rather, a willing buyer would purchase the IRA's constituent assets. Thus, unlike the cases E cites, the tax liability is no longer a factor. Neither is lack of marketability, because a hypothetical willing buyer would not examine what he or she would pay for the unmarketable interest in the IRAs, but instead would consider what a willing buyer would pay for the underlying marketable securities. Any reduction in value for built-in tax liability or lack of marketability is unwarranted.

The Fifth Circuit's reasoning in Smith, 391 F3d 621 (5th Cir. 2004), applies in the instant case. Smith also concludes that the application of the wilting buyer-willing seller test does not allow an estate to reduce the value of its retirement accounts by income tax liability.

See. 691

In Robinson, 69 TC 222 (1977), the Tax Court examined whether to discount the value of installment notes in an estate for future income taxes that the beneficiaries of those notes would pay on the income in respect of a decedent (IRD) included in future installments. The court determined that Sec. 691's statutory scheme obviated the need to give the taxpayer any further relief.

Sec. 691(a)(1) provides that "all items of gross income in respect of a decedent ... shall be included in the gross income, for the taxable year when received." This provision results in some double taxation. For example, installment notes transmitted by a decedent at his or her death would be included in the estate at FMV under Secs. 2031 and 2033; each portion of the future installment payments that represented taxable gain would be subject to income tax in the year of receipt.

Sec. 691(c) grants some relief from double taxation, by providing that the IRD recipient may deduct that portion of the estate tax levied on the estate that is attributable to the inclusion of the right to such income in the estate. Congress has chosen to ameliorate the effect of this double taxation, by allowing an income tax deduction for the estate tax attributable to the taxable gain--there is no foundation in the Code for supplementing this Congressional income tax relief by the additional relief that E seeks.

For example, in Smith, the court noted that Congress has not provided similar relief in cases of closely held corporate stock with capital gains potential. In cases involving closely held stock with built-in capital gain, the capital gain tax potential survives the transfer of the stock to an unrelated party; Congress has not granted any relief from that secondary tax.


A hypothetical buyer would not take into account the tax consequences of distributing the assets in the IRAs, because the buyer would be purchasing the securities, not the IRAs themselves. The tax liability associated with the distribution of the IRAs would not be passed on to the buyer. In addition, Sec. 691(c) provides relief from the double taxation that would be imposed on the IRA beneficiaries. Thus, the correct way to value the IRAs is based on their respective account balances on the date of the decedent's death.

EST. OF DORIS KAHN, 125TC 227 (2005)
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Title Annotation:individual retirement accounts
Author:O'Driscoll, David
Publication:The Tax Adviser
Date:Aug 1, 2006
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