IRS Says Family Corporation Should Be Disregarded for Tax Purposes and ignores Wyoming LLC precedent.
The IRS National Office recently issued a field service advice memorandum concluding that a family corporation established by a mother to reduce transfer taxes should be disregarded for estate tax purposes since it has no other business purpose and lacks economic substance
After discussing estate and gift planning with her attorney, a woman formed a family corporation and transferred cash and securities to it in exchange for all of its stock. She then made gifts of stock to her children, grandchildren, and great-grandchildren over the next few years, claiming discounts for minority interests and lack of marketability for all the gifts. These discounts reduced the value of each gift to each individual to the amount subject to the annual gift tax exclusion. So, according to her calculations, she owed no gift taxes on any of the transfers.
The IRS, however, concluded that the family corporation has no economic substance and that its only purpose is to eliminate the transfer taxes associated with the gifts to the donor’s family members. The National Office therefore advised that it would be appropriate to argue that the family corporation should be disregarded for gift tax purposes and that the donor made a gift of the underlying assets, not of interests in the corporation. (The National Office did admit, however, that the latter argument might be difficult to make for the gifts made in later years.)
The IRS also concluded that even if the family corporation is found to have economic substance, the discounts the mother claimed for minority interests and lack of marketability were excessive.
Of course, this field service advice cannot be cited as precedent and is meant only as guidance for the IRS. And we certainly learn that while the lord taketh he also giveth:
The IRS has acquiesced in a 1998 Tax Court ruling that I.R.C. § 2040(b)(1) (the “50% inclusion rule,” which was added in 1976) does not apply to joint interests created before 1977, even if the deceased joint tenant died after 1981.
This case [Hahn v. Comr., 110 T.C. 1040 (1998)] involved 440 shares of stock purchased in 1972 and owned jointly by a husband and wife (the Hahns) until the husband’s death in 1991. Ms. Hahn sold the shares in 1993 for less than her reported basis in the shares. She reported 100% of the date-of-death value [pursuant to §§ 2040(a) and 1014(b)(9)] in calculating the stock’s basis, and received a step-up in basis for all the shares.
The IRS determined that since Mr. Hahn had died after 1981, § 2040(b)(1) dictates that only 50% of the date of death value should be included in his gross estate. This would mean Ms. Hahn would receive a step-up in basis for only 50% of the shares, reducing her basis to less than the price at which she sold the stock and thereby causing her to incur capital gains taxes on the sale.
The Tax Court ruled that the 50% inclusion rule does not apply to spousal joint interests created before January 1, 1977, even if the joint tenant died after December 31, 1981. The contribution rule applies to such interests.
The government’s acquiescence indicates that the IRS will not appeal this ruling and will no longer seek to litigate such cases.