Bill Introduced to Freeze Estate Tax at 2009 Levels and to Eliminate Discounts on Nonbusiness Assets – Part II

February 13, 2009

Valuation discounts (particularly of the minority and marketability type) can significantly reduce what might otherwise have been the estate and gift tax values of transferred property. In contrast, the IRS often takes the position, on audit and in litigation, that application of these discount reductions should not be available for estate and gift tax purposes. For example, the Revenue Service has argued that a taxpayer may make gifts to a child of minority interests in property and incorrectly (in the Service’s view) claim lack-of-control discounts under the gift tax even though the taxpayer or the taxpayer’s child controls the property being transferred. The Service has also contended that a taxpayer, who contributes marketable property (such as publicly-traded stock) to a partnership (such as a family limited partnership) or other entity that he or she controls, may (when interests in that entity are transferred through the estate) inappropriately claim marketability discounts even though the heirs may be able to liquidate the entity and recover the full value by accessing the underlying assets directly.

H.R. 436 presents a standard for gift and estate tax purposes, with respect to discounts, that is sympathetic to those IRS articulated positions. Under the bill, in the case of the transfer of any interest in an entity, other than an interest which is actively traded:

“(A) the value of any nonbusiness assets held by the entity shall be determined as if the transferor had transferred such assets directly to the transferee (and no valuation discount shall be allowed with respect to such nonbusiness assets), and

(B) the nonbusiness assets shall not be taken into account in determining the value of the interest in the entity.”

The bill also contains a 10% “look-through” rule. Under this rule, if a nonbusiness asset of an entity consists of a 10% interest in any other entity, the bill would disregard the 10% interest and would treat the entity as holding directly its ratable share of the assets of the other entity. This rule would be applied successively to any 10% interest of the second entity in any other entity, thus seeking to prevent the circumvention of the “nonbusiness asset” discount disallowance through the use of a holding company structure.

Finally, the bill attacks “minority interest” discounts by providing that, in the case of the transfer of any interest in an entity other than an interest which is “actively traded,” no discount shall be allowed by the reason of the fact that the transferee does not have control of the entity if the transferee and members of the family of the transferee have control of the entity.

The Pomeroy bill’s proposed effective date is “date of enactment.”

The Association for Advanced Life Underwriting expects other proposals respecting the estate, gift and generation-skipping transfer taxes will follow this Pomeroy proposal. We will report promptly on them as they arise.

Source: AALU Bulletin No: 09-10, 1/23/09.