In a recent Tax Court opinion, Estate of Victoria E. Dieringer et al. v. Commissioner, 146 T.C. No. 8 (2016), the court upheld an estate tax deficiency of $4.1 million and an accuracy-related penalty of $824,943 in a charitable deduction case. The court determined that actions taken before the distribution of the assets by the estate, but after the decedent’s death, changed the nature of the assets and reduced the value of the property that was eventually transferred to the charitable foundation.
The estate claimed a charitable deduction for estate tax purposes based on an appraised date-of-death value of all of the shares intended by the decedent to be transferred to the foundation. However, not all the shares were distributed to the charity. Instead, all of the decedent’s voting shares and most of the non-voting shares were redeemed at a much lower (50 percent reduced) post-death appraised value, with the sales proceeds and remaining non-voting shares ultimately going to the charity. The court declined to use the estate’s claimed $14.2 million date-of-death appraised value, and instead used the significantly lower redemption value, to value the ultimate contribution to the foundation. In addition, the court imposed accuracy related penalties in an amount equal to 20 percent of the underpayment attributable to negligence with respect to an understatement of tax resulting from the overstated charitable deduction.
The decedent was the majority shareholder of a closely held real property management company. She had established a trust and a foundation with her son being the trustee of both. Under her will, all of her property went to the trust, but under the trust agreement, the company stock was to be distributed to one of her sons (acting as the trustee of the foundation) to distribute according to the trust agreement. Multiple events occurred after her death, but before the unredeemed non-voting stock in the company was transferred to the foundation, including:
- A change in the company’s tax status from a C corporation to an S corporation
- An amendment to the company’s redemption agreement authorizing a redemption of all of the voting shares and most of the non-voting sharing shares intended to be transferred to the foundation
- The children signing a subscription agreement to purchase additional shares of the company and to issue promissory notes to the company to complete the redemption
- A post-mortem appraisal with instructions to inform the appraiser to determine the value of the company stock as a minority interest.
The court noted the tax status change and redemption transactions were undertaken for valid business purposes, but found these events altered the estate plan. The court placed special emphasis on the changes in value between the initial date-of-death appraisal and the post-mortem redemption valuation, both of which were prepared by the same appraiser. The court found that the record did not support a substantial decline in the company’s per share value during these seven months, particularly where the underlying net asset value of the company had declined by less than 10 percent during the intervening period. The court determined the resulting decline in the appraised values of the company stock was primarily attributable to the appraiser valuing the shares as a majority interest for the date-of-death value, but as a minority interest with a 50 percent discount for the post-mortem redemption value.
Emphasizing that an interfamily transaction in a close corporation should receive a heightened level of scrutiny, the court ruled in favor of the government. Although I.R.C. § 2031 provides the value should be determined at time of death and no alternative date was elected under I.R.C. § 2032, the court found the facts agree with the principle in Treasury Regulation §20.2055-2(b)(1) that if a trustee is empowered to divert property for use that would have rendered it not deductible had it been directly bequeathed, the deduction will be limited to that portion which is exempt from that power.
The court viewed the post-mortem events, coupled with the son/trustee’s directions to value the stock as a minority interest, as depriving the foundation of the benefits the decedent intended to convey. By redeeming over 80 percent of the decedent’s shares at a “minority interest” value, rather than at the “majority interest” date-of-death value, the estate was claiming a charitable deduction at an inflated value relative to what the foundation ultimately received. The court concluded that the trust did not transfer the bequeathed shares, or the value of the bequeathed shares, to the foundation, and thus was not entitled to claim a charitable deduction as if it had done so.
In assessing the accuracy related penalty, the court found no reasonable basis existed to abate the penalty because of the post-mortem appraisal. The IRS established that the estate not only failed to inform the appraiser that the redemption was for a majority interest, but also instructed the appraiser to value it as a minority interest. The estate’s reliance on the attorney-advisor for a reasonable cause defense was rejected, because the attorney was advising on the basis of a defective appraisal.
The case is a reminder that the government will closely scrutinize transactions between family members when it comes to taxation of the estate, even if there are valid business purposes for completing the transaction.
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