A recent Tax Court case addressed some interesting issues relating to the estate tax value of an LLC interest. Below is a summary of these issues.
A. Valuation of An Interest as a Full Member Interest or an Assignee Interest. The operating agreement for the LLC interest provided that if an LLC interest is transferred outside of the family, the new owner is a mere assignee that cannot participate in management unless all of the other members vote to admit the new owner as a full member. At the time of the decedent’s death, the LLC interest at issue was owned by a trust, and included in the decedent’s gross estate via Code Section 2038. The interest in the hands of the trust was a full member interest.
The estate sought to value the transferred interest as an assignee interest only. The Tax Court declined, and said it should be valued as a member interest because that is what it was immediately before death. Nonetheless, since a buyer would consider the restrictions on transfer in the operating agreement in determining what it would pay, such nonfamily/assignee restrictions should still be a factor in the final valuation.
B. Net Value vs. Income Approach. The estate sought to value its LLC interest based on the historical distributions made to its members (i.e., an income approach), especially because it wanted to characterize the LLC as an assignee interest that could not participate in management.
The IRS instead valued the LLC interest based on a net asset value approach – valuing the assets of the LLC, deducting LLC liabilities, and then multiplying that net value by the percentage of the LLC attributable to the subject LLC interest.
Note that both approaches are the starting point for valuation – once a preliminary value for the interest is obtained then appropriate discounts for lack of control and lack of marketability as to the LLC interest are applied.
The court noted that a net asset method of valuation applies to mere holding companies since they are not managed for current income, while an earnings-based method applies to going concerns. It also noted a mixed net value and income/distribution capitalization approach has been applied in other cases for a closely held real estate firm. While the court did acknowledge that the rental of the LLC’s real estate constituted an operating business and thus suggested some focus on historical distributions to members, it applied the net asset value approach for the value of the LLC interest (even though the real estate itself had been valued using an income approach) – this was done partly because no evidence appears to have been accepted into evidence as to those values. Cases cited by the Tax Court for applying a mixed valuation approach were Estate of Andrews, 79TC 938 (1982) and Estate of Weinberg v. Commissioner, T.C. Memo. 2000-51. Thus, the case does not foreclose a mixed approach in general – just under the lack of evidence presented in this case.
C. It Can Be Difficult for a Taxpayer to Claim a Lower Value than Originally Reported. Here, the estate argued for a valuation lower than the value it reported on the estate tax return. This is often a negotiating tactic for estates on audit, and at other times such assertions of lower values are wholly bona fide after a different set of professionals review the initial reporting. The Tax Court was resistant, noting:
"[V]alues or discounts reported or claimed on an estate tax return may be considered admissions and, to some extent binding or probative, restricting an estate from substituting a lower value without cogent proof that those admissions are wrong.” Estate of Deputy v. Commissioner, T.C. Memo. 2003-176 [TC Memo 2003-176], 2003 WL 21396789, at *5 n.6; accord Estate of Hall v. Commissioner, 92 T.C. 312, 337-338 (1989). We have no cogent proof that the value that petitioner relied on in reporting the value of the subject interest on the Schedule G is wrong.
Estate of Diane Tanenblatt, et al. v. Commissioner, TC Memo 2013-263