FIRST, A SIMPLE question: How much would you pay for property worth $ 100,000, if you must spend $30,000 to fix it ( commissions, special taxes or whatever) before or after selling it? Certainly not more than $70,000. Or less, if you want to make a profit.
Yet, over the years the IRS and the courts just didn't understand basic economics in the real world. Now they do.
Second, let's set up the scenario that is repeated every time business owners want to sell their businesses.
If you are a potential buyer, generally you are willing to pay more for the individual assets owned by the corporation than the corporation's stock. You do this for two reasons: To obtain a higher tax basis for the low-basis assets owned by the corporation and to avoid hidden corporate liabilities. But now look at the seller's side: After the acquired company sells its assets, it will owe corporate income tax on any gain (realized on the sold assets).
On the other hand, if the shareholders sell their stock, they will pay less tax. But the low-tax basis of the assets stays with the corporation. So now, when the buyer (now the new owner of the acquired corporation) sells these assets, the corporation (the new owner) will be socked with the tax on the gain.
Despite this reality, the IRS and the courts have never allowed a reduction in the value of corporate stock for potential taxes due on a future asset sale or corporate liquidation. That is, not until the courts finally saw the light. Two bellwether cases allowed such a discount for the first time.
Case No. 1. 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. Davis gave about a 26% interest in the holding company to each of his two sons. At the time of the gift, the holding company owned $70 million of Winn-Dixie stock and $10 million of other assets.
You'll love this part. Davis claimed three discounts on his gift tax returns to report the transfers: lack of marketability, minority interest and for the corporate taxes due if the Winn-Dixie stock were to be sold. The total of these discounts reduced the value of the gifted stock by more than 60% when compared to the real value of the holding company's assets.
The IRS rejected the valuation and assessed additional gift taxes of $5.2 million. Davis fought the IRS. When he died, his estate continued the fight. The smart Tax Court held that a discount for taxes must be allowed. The court saw no way the holding company could avoid the taxes and allowed discounts totaling 50% of the value of the assets.
Post this column on the wall. When you want to transfer your business for tax purposes, reread it. Hey, that's about $500,000 off every $1 million your business is worth. (A little side note to blow our horn — the valuation department of our office has been successfully taking advantage of the same three-discount strategy for years.)
Case No. 2. Irene Eisenberg, 155 F3d 50-1998. In this case, the corporation owned real estate that it rented to third parties. The Second Circuit concluded that a similar discount (also for taxes) was appropriate in valuing stock owned by a holding company.
And here's one more reason to keep this column handy. We often use a family limited partnership to beat up the IRS legally. A FLIP usually owns real estate and marketable securities just like the two cases discussed above. These two victories give us big-gun ammunition should the IRS get any low-discount ideas.
My resources online
I've been writing a column for about 35 years. During that time I've written hundreds of articles, dozens of special reports and a score of books. All about taxes, business transfers, life insurance, different types of trusts and controlling your assets. I've literally got a small mountain of stuff. Most of it is updated and current.
On a regular basis, I get phone calls, letters, faxes and e-mails from readers of this column. They contain all kinds of questions and unsolved problems, usually dealing with one or more of those subjects. In almost every case, the answer or solution is somewhere in my stuff.
By now you probably know where this is going — to the Web. To be precise, www.taxsecretsofthewealthy.com (my Website). It's got a ton of my stuff.
There's even a section that approaches your planning questions and problems from the size of your wealth: from the Little Guy (no estate tax liability) to the Billionaire, with four based on the-amount-of-your-wealth categories in between. A whole area is dedicated to professionals, telling 'em what to do and how to do it to help their clients.
In general, the Website is designed to answer the most-asked questions and solve the most-commonly proposed problems. There's also some material that comes up rarely but can save or make you millions of dollars.
Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; tel. 312/ 207-1040, or via e-mail at [email protected]