May 26, 2004 -- The lack of a supportable business valuation may provide a sufficient reason for the U.S. Tax Court to reject an estate plan, as the following example will illustrate.

In the case of the Estate of Ida Abraham – T.C. Memo. 2004-39, February 18, 2004 , the court refused any discount for three family limited partnerships (FLP) due to a questionable appraisal.

The facts of the case are: Nicholas Abraham passed away on June 5, 1991 , leaving the majority of his $7 million estate to his wife Ida Abraham. In 1993, when Ida Abraham’s health became a concern, her daughter was appointed guardian of her property and estate. The daughter and her three siblings then petitioned the court and in 1994 created and funded three family limited partnerships. Each child transferred $160,000 to Mrs. Abraham for certain partnership interests. The price paid was based on an appraisal in which the appraiser determined that a 25-percent marketability discount and a 15- percent minority interest discount were appropriate. The appraiser’s opinion letter included a disclaimer stating, “no representation is made that these discounts will hold up.” The income generated from the partnerships was used to maintain and support Mrs. Abraham.

Under Estate and Gift Tax Code Section 2036(a), a decedent’s gross estate includes the value of any transferred property, or interest in property, in which the decedent reserved or retained an interest, except for property transferred in a bona fide sale for adequate and full consideration.

The estate plan caught the attention of the Internal Revenue Service and the case was sent to United States Tax Court. The Abraham children argued that the interests in the family limited partnerships were purchased for adequate and full consideration (based on the appraisal) and thus the sale should qualify for Section 2036(a)’s “bona fide sale” exemption.

The Tax Court however, rejected the estate’s claim that the children provided adequate and full consideration for the FLP interests despite obtaining a letter opinion establishing the discount for lack of marketability and minority interest discount. The Court contended that the letter failed to disclose the underlying basis for its conclusions and disclaimed any reliance on it for gift and estate tax purposes. It stated, “While we agree that in certain circumstances discounts may be appropriate in valuing interests in property, nonetheless there must be some showing that the discounts taken were appropriate.”

One of the lessons to be learned from this case is that in order to qualify for valuation discounts, you must have a full and supportable valuation. If the discounts cannot be supported, the IRS and the Tax Court will reject them.

For more information, contact an Asher professional at 215-564-1900.

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