First came Estate of Christiansen v. Commissioner, 2009 WL 3789908 (C.A.8), in which the Eighth Circuit upheld an estate's formula disclaimer of assets. Next, the Tax Court strongly affirmed the use of defined value clauses in Estate of Petter v. Commissioner, 2009 WL 4598137(U.S. Tax Ct.). This "one-two" punch may have knocked out the IRS's strong public policy arguments against these types of structured gifts, representing an important recent development in estate and tax planning.
Did the Tax Court wait for the feds? The Tax Court was deciding Petter while Christiansen was still pending in the Eight Circuit. Judge Holmes-who wrote the original opinion in Christiansen and was preparing to write Petter-probably waited to see how the Eighth Circuit would rule, because he issued Petter just about three weeks later.
In Christiansen, the taxpayer's daughter structured a disclaimer of her inheritance to keep part of it and give the rest to charity. The formula was complicated: the numerator was the fair market value of the gift, less $6.35 million, and the denominator was the fair market value of the gift on a certain date, "as finally determined for federal estate tax purposes."
"The Commissioner quibbled with this clause because he said it worked to reallocate gifts after an audit," Judge Holmes observed, discussing the case in Petter. The IRS also invoked its standard arguments to defeat the additional charitable deduction that resulted from the daughter's disclaimer; i.e., the adjustment clause was a condition subsequent and contrary to public policy. "But we sided with the taxpayer," Holmes wrote (and so did the 8th Circuit). Read More...
Valuing Goodwill in Divorce: Communication and Consistency are Critical
Two recent divorce decisions demonstrate how important communication among the client, counsel, and financial expert(s) can be in any given case, especially when the primary asset is a professional practice. Calculating a credible goodwill value requires the expert to have adequate disclosures, accurate data, and a complete understanding of appropriate methodologies.
Husband's expert gets a surprise at trial. In re Marriage of Theurer, 2009 WL 3823648 (Cal. App.)(unpublished) considered a well-established orthodontist with 14 people on staff, all the latest technology, and up to 150 patients per day. The practice grossed $2.6 million, earning the husband $1.3 million before tax. Notably, he averaged 921 new patients per year-more than three times the average.
At trial, the wife's expert used the excess earnings approach, estimating the husband's reasonable compensation at $500,000, a goodwill value of $2.5 million and an overall practice value of $3.0 million. Similarly, the husband's first expert used the earnings approach, but applied a lower cap rate and higher compensation ($776,000) to reach a goodwill value of approximately $990,000, plus tangible assets. He then deducted patient prepays as a liability (over $1.1 million), for a final practice value of only $126,905. Read More...
Two Taxpayer Victories Demonstrate Winning Facts for FLPs
As textbook examples of how to form, fund, and operate a family limited partnership (FLP)-sufficient to value various assets (including publicly traded securities, real estate, and restricted holdings) at substantial discounts for federal estate tax purposes-the Murphy and Black cases make excellent reading for attorneys and financial advisors alike.
Legitimate business purpose proves critical. The Murphy Oil Corp. grew from a small family-owned business into a $2 billion international conglomerate. During the 1990s, Mr. Murphy established an FLP with $89 million in company stock plus bank and real estate holdings. Importantly, this represented only half his net worth and he never mingled his personal assets with the FLP's. Overall, the father retained a 95% limited partnership interest in the FLP, with his two sons in charge of daily operations.
For five years, the FLP traded assets, managed employees, held regular meetings, and prepared regular statements. It made only two distributions, with appropriate adjustments to the partners' capital accounts. After the father died unexpectedly in 2002, the IRS cited over $34 million in tax deficiencies and the estate sued for a refund. In Murphy v. U.S., 2009 WL 3366099 (W.D. Ark.), the federal court found the FLP was created to:
- Pool and invest the family assets according to the father's philosophy;
- Pass management responsibility onto the next generation;
- Enable the father to gift interests in the FLP while the underlying assets stayed under central management;
- Educate the father's heirs about wealth acquisition, management, and preservation; and
- Protect the family assets from creditors, divorce, and dissipation by future generations.
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Alabama Case Clarifies 'Equitable' Fair Value Standard in Divorce
Grelier v. Grelier, 2009 WL 5149267 (Ala. Civ. App.) In what could serve as precedent for states that now apply the broad, equitable standard for valuing businesses in divorce, the Alabama Court of Appeals just considered a case in which the husband owned a minority (25%) interest in several closely held, commercial real estate companies. A court-appointed expert valued the husband's interests a little over $1 million; the trial court adopted this value, but then applied the 40% combined discount for lack of marketability and lack of control advocated by the husband's expert, to reach a value of roughly $602,000. This reflected the "reality of the financial condition of the parties," the court held, including their substantial personal and business debt and the negative value of some of the company's properties.
Appeal based on statutory fair value. The wife appealed, arguing that it was inappropriate to apply marketability and minority discounts to closely held, ongoing business values in divorce. In addressing the issue of first impression, the Alabama Court of Appeals first considered case law from jurisdictions that apply a "fair market value" (FMV) standard in divorce. In those cases, "it makes sense to apply...discounts because those discounts reflect the economic reality that, unlike the case with publicly traded companies, no ready pool of willing buyers exists to purchase an interest in a private business organization that does not carry with it the ability to control that organization."
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