The Tax Court adopted the IRS's valuation of a revocable trust's interest in a business with mostly liquid assets, finding that the taxpayer's valuation overstated the marketability discount appropriate for the large size of the interest and the business's liquidity. The Tax Court also held that the estate was not entitled to deduct the projected interest expense on a "Graegin loan," finding it was unnecessary to borrow the funds to pay estate tax.
In this case, prior to the decedent's death, he sold his soft drink company and created a limited liability company (an "LLC") with the proceeds. At the time of the decedent's death, his revocable trust owned a 46.94% voting interest in the LLC. Prior to his death, however, the LLC offered to redeem the interests in the LLC owned by the decedent's children. A few weeks after the decedent's death, the redemption was completed, leaving the decedent's revocable trust owning a 70.42% interest in the LLC. Several months later, the LLC loaned the decedent's revocable trust $10,750,000 under a term promissory note at a 9.5% annual interest rate with principal and interest due in fourteen equal installments starting in 2024. The terms of the loan prohibited prepayment and the proceeds were to be used by the revocable trust to make a payment towards the estate and gift tax liabilities of the estate (i.e., a Graegin loan). At the end of the loan, the total interest payments paid to the LLC would be $71,419,497. Furthermore, at the time of the loan, the revocable trust's primary asset was the LLC, which had over $200 million dollars of liquid assets and two operating companies.
On the estate tax return, the revocable trust's interest in the LLC was reported at a value of $117 million and the estate claimed a deduction for the $71,419,497 interest expense. The Tax Court determined that the estate could not deduct the projected interest expense on the LLC loan because it was an unnecessary expense. As the revocable trust had a 70.42% interest in the LLC, the court found that the trust could force a pro rata distribution to the members, which made it unnecessary for the trust to borrow from the LLC.
Regarding the fair market value of the LLC interest reported on the return, the court analyzed the marketability discounts proposed by each party – the estate expert determined a 31.7% discount should apply, whereas the IRS's expert contended that a 7.5% discount was appropriate. The Tax Court agreed with the 7.5% discount presented by the IRS's expert because (1) such expert took into account the redemption of the interests that had begun before the decedent's death and (2) the revocable trust could force a distribution of the LLC assets due to its 70.42% ownership.