In Estate of Richmond (February 2014), the Tax Court again addressed how a future liability for income taxes on built-in asset gain should be taken into account in determining the value of the stock of a closely held corporation for estate or gift tax purposes. In this case, a family holding company that was a C corporation owned a portfolio of publicly traded stocks. Most of the positions had been held for years, and the unrealized appreciation represented about 87 percent of the total value of the portfolio, so significant income tax would be payable by the corporation if it sold the portfolio.

There has been a lot of litigation over the past ten or more years on how a future tax liability should be taken into account for valuation purposes. There are differing views among the Tax Court and the Courts of Appeal that have considered the issue. The Fifth and Eleventh Circuits have allowed a discount for 100 percent of the future tax liability on built-in asset gain when valuing the shares of a company that owns the built-in gain assets. The Second and Sixth Circuits, along with the Tax Court, have taken the view that future recognition of the gain is not certain and there may be things that can be done to mitigate the future tax liability. These courts have allowed a discount of something less than the full amount of the future tax.

In the Richmond case, the Tax Court followed the IRS expert witness’s opinion that the correct discount was 43 percent of the future tax liability. The expert had based his opinion on the discount for future taxes reflected in the price of shares of closed-end mutual funds.

The case also presented other interesting issues. The estate’s expert had valued the holding company shares before applying any discounts by capitalizing the dividend stream that the portfolio produced. The court said that discounting future cash flow was not an appropriate valuation method for assets that have daily published trading prices such as the stock portfolio in this case.

Significantly, the court also agreed with the IRS that the valuation understatement penalty should be imposed. The court pointed out that the initial appraisal for the estate was done by a CPA, rather than by a certified appraiser. The court also noted that at the time the estate tax return was filed, the taxpayer had received only an unsigned draft of the appraisal report and said a taxpayer could not rely on an unsigned draft for purposes of filing the return.