The Tax Court recently held that a note does not constitute a qualified family-owned business interest (QFOBI) for purposes of IRC § 2057, which allows an estate to deduct up to $675,000 from its value for estate tax purposes. To qualify for the deduction, the value of the QFOBI at the time of death must exceed half the value of the adjusted gross estate. This 50% liquidity test, found in section 2057(b)(1)(C), was at issue in Estates of Duane and Lois Farnam v. Commissioner.
The Farnams, of Minnesota, operated a family business of automobile parts sales as Farnam Genuine Parts Inc. To fund the company’s operation, the couple loaned it money over several years in return for unsecured promissory notes. Duane Farnam died in 2001 and Lois Farnam in 2003. Both their estate tax returns claimed deductions for QFOBIs, which the IRS disallowed in 2005.
The issue before the court was whether the notes constituted interests for purposes of the 50% liquidity test. Section 2057(e)(3) defines family ownership in the case of a corporation in terms of the amount of stock held by family members or, in the case of a partnership, capital interest. The decedents’ estates argued that section 2057(e)(3) applies only to determining whether an entity is family-owned and noted that the definition of a QFOBI in paragraph 2057(e)(1) does not similarly specify an equity or capital interest.
The Tax Court, however, agreed with the IRS that the QFOBI definition should be read as limited by the terms of the family ownership test. It would be “illogical to divorce the equity ownership requirements” of the latter from the former, the court said. The court thus held that the loans did not constitute QFOBIs and upheld the resulting deficiencies of $763,131 for the estate of Duane Farnam and nearly $1.5 million for that of Lois Farnam.
n Estates of Duane and Lois Farnam v. Commissioner, 130 TC 2
Prepared by Laura Lee Mannino, CPA, LL.M., assistant professor of accounting and taxation, St. John’s University, Jamaica, N.Y.