Tax Secrets of the Wealthy: Thank you tax court for finally understanding

A high-five business valuation victory for the good guys

First, a simple question: How much would you pay for property worth $100,000, if you must spend $25,000 (to fix it: commissions, special taxes or whatever) prior to collecting your $100,000? ... Certainly not more than $75,000 … Or less, if you wanted to make a profit.

Yet over the years the IRS and the courts just didn’t understand basic economics in the real world, (and how to answer the above question). Now they do. Here’s the story.

Let’s set up the scenario that is repeated almost every time business owners want to sell their businesses. If you are a potential buyer, generally you are willing to pay more for the individual assets owned by the corporation than for the corporation’s stock. Why? You do this for two reasons: (1) To obtain a higher tax basis for the low-basis assets owned by the corporation; and, (2) To avoid hidden and contingent corporate liabilities.

Now, let’s look at the seller’s side of the coin: After the company sells its assets, it will owe corporate income tax (remember, corporations do not enjoy the luxury of low capital gains rates) on any gains. On the other hand, if the shareholders sell their stock, they will pay less tax (bless those low — 15 percent — capital gains tax rates). But (ouch!) the low-tax basis of the assets stays with the corporation. Sorry, if the buyer (really your former corporation) sells those assets, the corporation will be socked with high corporate income tax rates on the gain.

Despite this reality, up until now the IRS and/or the courts have never allowed a reduction in the value of corporate stock for potential taxes due on a future asset sale or corporate liquidation. Sound the victory bell, two 1998 cases allowed such a discount for the first time. Best of all, the well-reasoned decisions are still the law today. From time to time new cases are ruled on by the courts with the same or similar facts. The IRS always loses, with the courts citing the two cases that follow.

Case one: Estate of Artemus Davis, (110 TC 530-1998). Davis, one of the founders of the Winn-Dixie grocery chain created a holding company to own some of his publicly traded Winn-Dixie shares. Davis gave about a 26 percent interest in the holding company to each of his two sons. At the time of the gift, the holding company owned $70 million of Winn-Dixie stock and $10 million of other assets.

You’ll love this part. Davis claimed three discounts on his gift tax returns to report the transfers: (1) Lack of marketability; (2) Minority interest; and (3) For the corporate taxes due if the Winn-Dixie stock were to be sold. The total of these discounts reduced the value of the gifted stock by more than 60 percent when compared to the real-dollar value of the holding company’s assets.

The IRS rejected the valuation and assessed additional gift taxes of $5.2 million. Ouch! Davis fought the IRS and when he died, his estate continued the fight. Thumbs up! The tax court held that a discount for taxes must be allowed. The court saw no way the holding company could avoid the taxes and allowed discounts totaling 50 percent of the value of the assets.

Post this article on the wall. When you want to transfer your business for tax purposes, reread it. Hey, that’s about $500,000 off of every $1 million your business is worth. (A little side note to blow our CPA’s firm horn. The valuation department of our office has been successfully taking advantage of the same three-discount strategy for over 20 years.)

Case two: Irene Eisenberg, (155 F3d 50-1998). In this case, the corporation owned real estate that it rented to third parties. The Second Circuit concluded that a similar discount (like the Davis case) for taxes was appropriate in valuing stock of a holding company.

And here are two more reasons to keep this article handy: (1) We often use a family limited partnership (FLIP) — to beat up the IRS, legally — when a client owns investment property, like real estate and/or marketable securities and wants to transfer (taking discounts in the 35 to 40 percent range) them during life as a gift. So if you have a significant amount of investment property, look into a FLIP. (2) When a client owns a family business and wants to transfer it to younger family members, a powerful tax strategy we use is to combine a valuation discount with an intentionally defective trust (IDT). The little-known tax result of an IDT is that the owner of the family business (usually Dad) can pass the business tax-free (no income, gift or estate tax). Yes, it’s true, no tax to dad. No tax to the kids who wind up owning the business. Bonus: Dad maintains absolute control of the business for as long as he lives.

Want to learn more about these three — valuation discounts, FLIPs and IDTs — tax killers? Take a look at my Web site, There’s a ton of beat-up-the-IRS-legally and easy to understand info. Or have a question, call Irv (847-674-5295).

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection. E-mail him at or call 417-9732. His Web site is

© 2009 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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