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Estate & Gift Tax Planning

A common goal in estate and gift tax planning is to maximize the wealth transferred to beneficiaries while minimizing the taxes paid to the government.   A contemporaneous valuation of the assets transferred is necessary to ensure that the estate plan withstands IRS scrutiny and serves as durable admissible evidence in any future legal challenge to the validity of an estate plan designed to preserve wealth for the intended beneficiaries.  The estate and gift tax filing requirements can be complex and we work closely with the client’s legal and tax advisors who have extensive training and experience in this area.

While valuation discounts for lack of control and lack of marketability often result in lower tax liability, taxing authorities now require a detailed quantitative analysis of the factors specific to the asset being valued in order for such discounts to be recognized.

There are a multitude of lesser known factors that can substantially reduce the value of a taxable estate or gift.  These include:


Discounts for Built-in Gains Tax

A built-in gains discount represents the reduction in value of stock in a corporation that would be subject to capital gains taxes upon selling appreciated assets. A rational buyer of a C corporation equity interest would typically discount the price paid in recognition of the fact that a future capital gains tax liability decreases the value of the business.


Tax-Affecting Pass-Through Entities

Up until the late 1990s, it was common practice to tax affect all entities at a 40-percent tax rate or at the median effective tax rate of the public company guideline group. In 1999, the Gross vs. Commissioner decision issued by the Tax Court (T.C. Memo 1999-254, affd. 272 F 3d 333 6th Cir. 2001), concluded that S corporation shares are inherently more valuable than C corporation shares. This case and other notable cases led to the requirement to support such discounts with quantitative valuation models that take into consideration corporate governance provisions, corporate distribution policy, returns on comparable alternative investments, holding periods, and tax rates.  This is the essential issue to address in C-corporation to S-corporation conversions in order to limit and even avoid taxation of a corporation’s appreciated assets.  To read more about this topic, click here.


Tax Treatment of Goodwill

In the sale of a closely held business, a valuation issue that arises is whether the owner’s goodwill belongs to the corporation and should be included in the value of the business, or is the owner’s personal goodwill an asset that can be transferred separately from the value of the business. In general, the sale of a C corporation through an asset sale structure will result in two levels of income tax:

  1. A taxable gain to the corporation
  2. A taxable distribution to the shareholders

One strategy for closely held corporation share­holders to avoid this double taxation involves taking the tax position that a portion of the business sale relates to the sale of the personal goodwill of the shareholder/ employee. Therefore, a portion of the total purchase consideration should only be taxed once—as a capi­tal gain to the shareholder/employee directly.

The issue of personal goodwill was first addressed in Revenue Ruling 57-480, 1957-2 CB 47 and clarified by Revenue Ruling 60-301, 1960-2. The IRS concluded that personal goodwill did not attach to the corporation to the extent that the business is dependent upon the professional skill or other personal characteristics of the owner. Transferable corporate goodwill exists only when the business is not dependent on the professional skill or other personal characteristics of the owner. Corporate goodwill is the value in excess of identifiable tangible and intangible assets that stays with the business exclusive of personal goodwill.

The importance of this issue is apparent when it is determined how the sale proceeds will be characterized for tax purposes (capital gain versus ordinary income to the seller), as well as whether the buyer can claim an expense deduction when part of the purchase price is allocated to a covenant not to compete.

In the case of Larry E. Howard v United States of America (CA9 108 AFTR2d), the court decided that capital gains treatment applied if the buyer purchases the goodwill directly from the shareholder. However, if the goodwill belongs to the corporation, then even sale proceeds paid to the shareholder could be considered a constructive distribution and subject to double taxation and higher ordinary income tax rates.