Summary of a Recent
Judicial Development in
Estate Planning & Taxation

Discounting Minority Ownership Interests for Built-In Capital Gains Taxes,
Lack of Control, and Lack of Marketability

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In Estate of Litchfield v. Commissioner, T.C. Memo 2009-21, 2009 WL 211421 (T.C. Jan. 29, 2009), the United States Tax Court held that an estate's valuation discount of its minority stake in two S-corporations for built-in capital gains taxes and lack of control were appropriate, but found that the estate's discount for lack of marketability was higher than marketability discounts reflected in modern benchmark studies and thus reduced that discount accordingly.

Background

In valuating an estate's assets in connection with the preparation of the estate's federal estate tax return, the estate's valuation expert discounted the estate's minority stake in two S-corporations for built-in capital gains taxes, lack of control, and lack of marketability. Id. at *4. The Internal Revenue Service (IRS) audited the estate and issued a notice of deficiency in the amount of $6,223,176, and the estate appealed to the tax court. Id. at *4-5.

Arguments

The parties' experts both used the net asset valuation method in their appraisals of the fair market value of the estate's minority stock interests, but they applied different factual assumptions and different methods in valuating discounts and arrived at different conclusions. Id. at *8-16.

Analysis and Holdings

The court found that the estate's expert's assumptions were based on more accurate data than the IRS's assumptions, and it held that the estate's estimated built-in capital gains tax discounts were appropriate. Id. at *14-15. The court also noted that, regarding the lack of control and lack of marketability discounts, the IRS compared the minority interest with publicly traded entities and did not break down its discount analysis by asset class, whereas the estate's expert compared it to restricted stock and did break it down by asset class. Id. at *10-12. Both experts calculated similar lack of control discounts for the corporation's farmland and related assets, and both averaged their discounts for the farmland and for the securities to determine a lack of control discount. Id. at *15. However, the estate's expert used a weighted average to account for the fact that the corporation had significantly more farmland than securities, whereas the IRS's expert used a straight average. Id. The court reasoned that a straight average was not appropriate because the corporation's farmland and securities holdings were not roughly equivalent, and thus concluded that the estate's expert's lack of control discount was appropriate. Id. at *15-16. However, the court determined that the estate's lack of marketability discounts should be reduced because the estate's expert used outdated data relating to restricted stock discounts, which made his estimate higher than marketability discounts reflected in benchmark studies. Id. at *16.

The case was decided on January 29, 2009.