Minority interest discounts apply to charitable bequests

The Tax Court partially upholds gift and estate tax deficiencies involving real estate LLC interests held by a family trust and includible in a decedent's estate.
By Matthew T. Schippers, CPA, J.D., LL.M.

The Tax Court redetermined the value for gift and estate tax purposes of interests in limited liability companies (LLCs) holding real estate, ground leases, and leased-fee interests and upheld the IRS's determination that a discount applied to property split between two charitable donees.

Facts: Miriam Warne died on Feb. 20, 2014. Two sons and three granddaughters survived her. Warne and her husband had created the Warne Family Trust in 1981. At the time of her death, the trust was the majority interest holder of five LLCs: WRW Properties, VJK Properties, Warne Ranch, Warne Investments, and Royal Gardens.

WRW was a real estate holding company with leased-fee interests in two properties. VJK was a real estate holding company with a leased-fee interest in another property. Under the trust, Warne left 75% of Royal Gardens to the Warne Family Charitable Foundation and the remaining 25% to St. John's Lutheran Church.

In December 2012, Warne gifted partial LLC interests to her sons and granddaughters. The gift tax return filed by the estate in May 2015 reported a gift to one son of an 18% interest in WRW, a gift to the other son of a 22% interest in Warne Ranch, and gifts to each granddaughter of a 0.4% interest in VJK.

Also in May 2015, the estate filed an estate tax return reporting date-of-death values for Warne's interests in the five LLCs and the donations to the foundation and church, both reflecting the property's gross estate value.

Issues: The value of a gift is the fair market value (FMV) of the property on the date the donor made the gift (Sec. 2512(a)). A decedent's gross estate is the FMV of the decedent's property on the date of death (Secs. 2031(a) and 2032).

The IRS issued notices of deficiency to the estate for gift and estate tax. For the gift tax, the IRS determined increases in the FMVs of Warne's 2012 gifts of WRW, Warne Ranch, and VJK. The IRS also determined an addition to tax for failure to timely file (Sec. 6651(a)(1)). For the estate tax, the IRS determined a deficiency of $8.35 million due to increases to the date-of-death valuations of the five LLCs and a decrease of the estate's charitable contribution deduction.

The estate filed Tax Court petitions challenging both the gift and estate tax deficiencies. The issues analyzed by the court were: (1) the FMVs of interests in three of the properties for the 2012 gifts and the 2014 date of death; (2) the discounts for lack of control and marketability for the trust's LLC interests; (3) whether the Sec. 6651(a)(1) failure-to-file penalty applied; and (4) whether minority interest discounts applied to the charitable bequests to the church and the foundation. The estate's and IRS's valuation experts used differing methodologies, yielding divergent conclusions on valuation and discounts.

As for minority interest discounts applied to the charitable bequests, the IRS argued the charitable contribution deduction should report the benefit received by the foundation and the church. In contrast, the estate argued the discounts were inappropriate and would undermine the public policy of encouraging charitable donations. The estate claimed that because all of Royal Gardens was includible in the gross estate and the estate donated its entire interest in the property to the charities, the estate should be entitled to a deduction of 100% of Royal Gardens' gross estate valuation.

Holding: The court considered expert testimony by the parties' appraisers for the valuations of three properties as of the 2012 gifts and the 2014 date of death. For each property and for each date, the court adopted a price-per-unit valuation in between the valuations of the opposing appraisers. As for discount rates, the court adopted the estate's appraiser's rates, finding his use of the yield-capitalization approach appropriate for determining the leased-fee values.

The court found a "slight" discount for lack of control of 4% appropriate. Regarding the discount for lack of marketability, the court adopted the estate expert's discount of 5% because he provided a more credible analysis of the LLCs' restricted stock equivalent discounts. Further, the court held the Sec. 6651(a)(1) addition to tax applied because the estate failed to establish reasonable cause for its late filing of Warne's 2012 gift tax return.

The court looked to Ahmanson Foundation, 674 F.2d 761 (9th Cir. 1981), in analyzing the charitable contribution discount. In Ahmanson, the decedent owned a corporation with 100 shares. He bequeathed the one voting share to his son and the 99 nonvoting shares to a charitable foundation. For estate tax purposes, the entire interest of an asset held by the estate is valued without regard to how the estate disposes of the asset. However, when property is split as part of a charitable contribution, the focus is not on what the estate contributed but on what the charitable organization receives. Accordingly, the Ahmanson estate's deduction for the 99 nonvoting shares required a 3% discount due to the foundation's lack of voting rights.

Similarly, the court determined Warne's estate must include 100% of Royal Gardens in the gross estate but could deduct only the discounted interests received by the church and the foundation, reflecting a 27.385% discount for the donation to the church and a 4% discount for the donation to the foundation.

  • Estate of Warne, T.C. Memo. 2021-17

— By Matthew T. Schippers, CPA, J.D., LL.M., Triplett Woolf Garretson LLC, Wichita, Kan.

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