Estate of Marie J. Jensen

The Tax Court conceded to a taxpayer's dollar-for-dollar discount for built-in capital gains tax liability.

Facts

In Estate of Marie J. Jensen (T.C. Memo. 2010-182), the Tax Court accepted the Estate’s determination of the built-in long-term capital gains (“LTCG”) tax discount that was applied in computing the value of its ownership interest in a closely held C-corporation.  The decedent, Marie Jensen, was a resident of New York when she died on July 31, 2005.  In February 2003, Ms. Jensen created the Marie J. Jensen Revocable Trust (the “Trust”) and appointed herself trustee.  The corpus of the Trust included 164 shares of common stock in Wa-Klo, Inc. (“Wa-Klo”).  The principal asset of Wa-Klo was a 94-acre waterfront parcel of real estate that extended across the city lines of Jaffrey and Dublin, New Hampshire.  The real estate was improved by many state-of-the-art facilities, and Wa-Klo utilized its property to operate a summer camp.

The Estate hired Margolin, Winer, & Evens LLP (“MWE”) to value the Estate’s 82% interest in Wa-Klo as of the date of Ms. Jensen’s death.  MWE noted that as of the date of Ms. Jensen’s death, neither a sale or liquidation of Wa-Klo (nor a sale of its assets) was imminent or planned.  MWE used an adjusted book value method and estimated a built-in LTCG tax.  MWE subtracted the built-in LTCG tax from the net asset value and calculated an after-tax net asset value for Wa-Klo.  MWE concluded that a dollar-for-dollar discount for the built-in LTCG tax was appropriate.

The Internal Revenue Service (“IRS”) determined a different discount for the built-in LTCG tax.  The IRS examined closed-end funds to calculate the built-in LTCG tax.  The IRS also claimed that the discount for the built-in LTCG tax should be reduced due to the existence of alternate methods to avoid the payment of such tax (i.e., C to S corporation conversion or section 1031 exchange).  This difference led to the IRS computing an estate tax deficiency and subsequently sending the notice of deficiency.  The IRS claimed that the discount calculated by the Estate for the built-in LTCG tax was excessive.

Holding

The Tax Court ruled that the IRS’s use of closed-end funds to value the Estate’s interest was erroneous.  The Tax Court “was not convinced that a viable method for avoidance of the built-in LTCG tax exists for a hypothetical buyer.”  The Tax Court determined the built-in LTCG based on a present value analysis.  Judge Vasquez projected the tax liability into future years, applied capital appreciation for the assets, and discounted the built-in LTCG tax liability to its present value as of the valuation date.  It is important to note that Judge Vasquez applied the same growth and discount rate (which essentially provided the same result as taking a current dollar-for-dollar reduction).  Thus, the Tax Court maintained that while the LTCG tax discount calculated by the Estate was not precise, the value was within the range of values that may be derived from the evidence.  A full copy of the case can be found at www.ustaxcourt.gov/InOpHistoric/EstateJensen.TCM.WPD.pdf.

Discussion

The outcome of this case is the latest in a series of trends supporting the use of a discount for built-in LTCG tax.  After the repeal of the General Utilities doctrine¹ in the Tax Reform Act of 1986², the Estate of Davis v. Commissioner³ allowed a discount for the built-in LTCG tax liability on the basis of the facts and circumstances.  Following Estate of Davis v. Commissioner, the Tax Court applied a present-value approach based on all the facts and circumstances in subsequent valuation cases to determine such discount.⁴ Most recently, Estate of Dunn v. Commissioner (Fifth Circuit) and Estate of Jelke v. Commissioner (Eleventh Circuit) allowed discounts for the built-in LTCG tax in full.

The Estate of Marie J. Jensen is an example of all the prior cases and facts that must be considered when computing the discount for built-in LTCG tax.  It is interesting to note that the Tax Court left open the issue of whether a dollar-for-dollar discount is actually appropriate.  The Tax Court allowed the discount as it fit within the range of values it calculated.  However, the reasoning leaves the dollar-for-dollar discount issue open for appeal to the Second Circuit.

As different circuits have allowed dollar-for-dollar discounts, the question becomes: Is a dollar-for-dollar discount for built-in LTCG appropriate?  We believe the answer is “yes.”  While certain circuits have favored a present value approach, we find this method to be a highly speculative exercise.  There are a fair number of assumptions that need to be made in the present value calculation – i.e., the holding period, the growth rate, the discount rate, and future tax rates.  Each assumption could impact the amount of the built-in LTCG.  There is no definitive way to determine what the above factors should be in each case.  Furthermore, it is extremely unlikely that a hypothetical buyer will create a present value scenario to determine the amount of the built-in LTCG tax.  It seems far more reasonable that a hypothetical buyer would concentrate on the current value of the built-in LTCG tax and want to deduct that full amount from the purchase price.

Therefore, we believe that the rulings in the Fifth and the Eleventh Circuits that allow for the dollar-for-dollar built-in LTCG tax discount are more appropriate.  As we are located in the Fourth Circuit, there is no certainty that this approach will be accepted.  However, we believe that our method for calculating the built-in LTCG is supported by previous rulings and logic.

Valuation Services, Inc. is available to provide assistance with any valuation issues that you may have with your clients.

¹ The General Utilities doctrine originated in General Utils. & Operating Co. v. Helvering, 296 U.S. 200 (1935).

² Pub. L. 99-514, sec. 631, 100 Stat. 2269.

³ 110 T.C. 530, 538 (1998).

⁴ See Estate of Litchfield v. Commissioner, T.C. Memo. 2009-21; Estate of Jelke v. Commissioner, T.C. Memo. 2005-131, vacated 507 F.3d 1317 911^th Cir. 2007); Estate of Borgatello v. Commissioner, T.C. Memo. 2000-264, Estate of Dunn v. Commissioner, T.C. Memo. 2000-12, revd. 301 F.3d 339 (5^th Cir. 2002); Estate of Jameson v. Commissioner, T.C. Memo. 1994-43, vacated 267 F.3d (5^th Cir. 2001).

NOTE: This article does not constitute legal, valuation, tax or any other type of consulting advice. It is offered as an information service to our clients and friends. For specific legal and accounting issues, it is advisable to seek professional advice. We welcome the opportunity to discuss any specific valuation issues that you may have.

Craig Stephanson, CPA, CVA is the President of Valuation Services, Inc. ("VSI"), a Washington, D.C. based firm that exclusively values closely held businesses and fractional interests in closely held businesses. Craig is a leading expert on the formation and valuation of family limited partnerships and specializes in the valuation of real estate partnerships for estate planning and administration, succession planning, divorce proceedings, partner disputes and litigation.

Jeff Bae, JD, AVA is a Principal at VSI. Jeff specializes in the valuation of operating businesses and closely held entities for purposes of estate planning and administration, tax reporting, litigation support, and financial reporting.

VSI is located at 12250 Rockville Pike, Suite 200, Rockville, Maryland 20852. For further questions or assistance with valuation issues, please contact us at (240) 292-0533 or e-mail us at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or This e-mail address is being protected from spambots. You need JavaScript enabled to view it .