TRA 97 Is Not the Only Reason to Review Existing Estate Plans Involving Closely Held Stock

The Taxpayer Relief Act of 1997 provided a tax benefit for family-owned businesses, allowing an exclusion from a person’s taxable estate. This is important to consider when making estate plans involving closely held stock. There have been significant cases and IRS rulings that affect estate planning for closely held stock. In a hypothetical scenario, a husband owns a successful closely held corporation and wants to retain it for his family. When he dies, his spouse and children will inherit the business. The Act has specific requirements that must be met to take advantage of this tax benefit. The IRS changed its rules and said that when valuing shares of a family-owned company, they won’t always consider all the family members’ shares together. This might help with estate tax planning. In valuing closely held stock, the size of the block of stock in a corporation is important, and having control of the stock adds value. Control means being able to make decisions for the corporation. To have control, you usually need to own more than half of the shares. If you have control of the stock, it can be worth more. The value of a person’s stock in a company can be affected by whether they have control over the company. When someone dies, the value of their stock is important for figuring out their estate. If they own 100% of the company, their stock is worth $3,000,000. But if they own less than 100%, control comes into play. If they own 50.1%, the value of their stock could be increased by 38.1% to reflect their controlling interest. But if they gave away just two shares before they died, their estate would no longer have control, and the value of their stock would go down. When someone dies and their closely held stock is passed on to their spouse or other beneficiaries, there can be tax consequences. If the stock has changed in value since the person’s death, there may be gains or losses when it is passed on. This can affect how much of the stock goes to the spouse and how much goes to other beneficiaries. A court case called Ahmanson Foundation v. United States showed how this can create problems when the first spouse to die owns a lot of stock in a company. If a husband owns a lot of stock in a company and wants to leave it to his wife when he dies, the IRS might not give the full tax break because the wife is only getting a minority share of the company. This means the wife might have to pay more in taxes than expected. In order to get the full marital deduction for the husband’s estate, additional stock would need to be added to the marital share at a discounted value. Because of this, the IRS reduced the marital deduction allowed, resulting in a decrease of $220,000. To get the maximum marital deduction, the personal representative would need to add 43 shares to the marital share. This means that only 499 shares, instead of 542, would be left to fund the credit shelter trust. As a result, the husband’s estate has lost the benefit of $103,200 that could have been contributed to the credit shelter trust. If the husband has no other assets to make up for this loss, part of his available unified credit will be wasted. The IRS recomputation of the marital deduction can have a big impact on how much stock is subject to taxation when the surviving spouse dies. This can lead to higher estate taxes for the surviving spouse. This is especially true when the first spouse owns a majority of the stock in a company. If the marital trust ends up with a minority interest in the company’s stock, it can result in even more taxes. This can be a big issue for large estates, and can even result in a reduction of the marital deduction. It’s important to carefully plan for these potential issues to minimize taxes. In the case of the Estate of Chenoweth, the deceased person owned all the shares in a small company worth $2,834,000. In their will, they left 51% of the shares to their spouse. The value of the shares for tax purposes was disputed, and the court agreed that the value could be higher due to the control the spouse had over the shares. This shows that when someone owns most of a company, the value of the shares can be affected by who inherits them. The Chenoweth decision is important because it allows for more of the husband’s assets to be distributed to his credit shelter trust upon his death. This means that his wife can receive a larger share of his estate. For example, if the husband leaves his wife some shares of stock and also uses a formula to give her more money, the stock could be valued higher if it comes with control over the company. This would result in his wife getting more money and less of his other assets needing to be used. Simply put, the husband’s assets can be distributed to his credit shelter trust in a way that provides significant tax benefits. This is because the specific distribution of the assets to the trust allows for certain tax advantages that would not be available if the distribution was done differently. As a result, the surviving spouse can receive a larger share of the husband’s assets without causing any tax issues. The consequences of using the Chenoweth approach when the will or trust provides for a marital deduction but does not specifically leave certain shares to the surviving spouse can result in income tax consequences that make the approach less desirable. This is because transferring the shares to the marital trust may result in the recognition of gain, which would reduce the amount passing to the credit shelter trust. It is important to consider this approach carefully and be prepared for potential challenges from the IRS. If this approach is used, the surviving spouse should consider giving away some shares to avoid potential issues in the future. The court ruled that when a spouse dies and leaves part of their stock to their spouse and part to a trust, they should be valued separately for tax purposes. This means that the value of the stock owned by the spouse and the trust is determined separately, and not together. The court said that this is because even though the trust and the spouse together own all of the stock, the value of the stock should be based on what a buyer and seller would agree on, not on family rules. The court also said that it was important that it was the first spouse who died, not the surviving spouse, who had control over how the stock in the trust was handled. The Bonner case is important because it says that a QTIP marital trust and the surviving spouse should be seen as separate for valuation purposes. This can be used to argue against the IRS’s claim that there is a control premium at the surviving spouse’s death, and to get discounts for both the trust and the surviving spouse’s interests. It also opens up possibilities for estate planning, like transferring 49 percent of closely held stock to a trust and getting discounts for both interests when the surviving spouse dies. The case didn’t discuss the consequences of powers given to the surviving spouse, so there are different theories about what kind of arrangement is needed to get a discount like in the Bonner case. In order to get a discount on stock for estate tax purposes, the surviving spouse can’t have any control over the stock in a marital trust. This means they can’t have the ability to decide what happens to the stock after they die. To make sure the discount applies, the best option is to use a specific type of marital trust called a QTIP trust, where the surviving spouse has no control during life or at death. If the surviving spouse does have some control, like the ability to give some of the stock away before they die, then the discount might not apply. However, this approach could be challenged by the IRS, so it’s important to consider the potential costs of an estate tax audit. So, imagine a situation where a husband owns all the stock in a big company, but it’s worth so much that he can’t give it all to his trust and another special kind of trust. In this case, it might be a good idea to split the remaining stock between a special trust and just giving it outright to his wife. If set up right, this would give his wife control over the company. Then, she could give away enough of the stock to make sure her estate isn’t too big when she dies. If she doesn’t get around to doing this before she dies, she can still rely on the special trust to help out. Proper planning is key when dealing with closely held stock in estate planning. It’s important to divide the stock among family members during the husband’s lifetime to maximize discounts at his death. By doing this, the estate can benefit from lack of marketability and minority interest discounts, reducing the value of the stock for tax purposes. This can help the surviving spouse and future generations to retain ownership of the corporation and minimize estate taxes. This article discusses changes to tax laws for family-owned businesses after 1997. It includes references to related articles and court cases. The author, a lawyer specializing in estate planning, probate, and taxation, also shares his education and professional background. He submitted this article on behalf of the Tax Law Section.

Source: https://www.floridabar.org/the-florida-bar-journal/tra-97-is-not-the-only-reason-to-review-existing-estate-plans-involving-closely-held-stock/