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An estate tax fight over valuation takes years to resolve

On Behalf of | Aug 3, 2016 | Trusts |

We haven’t covered estate taxes frequently in this blog, because the federal threshold for 2016 is $5.45 million per individual. That means that couples can pass $10.9 million without Federal gift and tax consequences. The yearly gift exclusion remains $14,000.

But for complicated estates, an audit of an estate tax return can lead to a long, uphill battle against the IRS. A case out of the Ninth Circuit provides an example. The details are reported here. In this post, we will discuss what happened and how to avoid this type of situation.

A limited partnership interest

The issue came up when a woman inherited about 41 percent of a forestry operation in Oregon. She filed an estate tax return with a value on her limited partnership interest of about $12.6 million.

The IRS audited the return and calculated the value of the interest at $35.7 million and then assessed an accuracy-related penalty of roughly $2.5 million.

The tax court litigation took more than five years and recently ended generally in favor of the taxpayer. Why the protracted litigation? Various methods of valuing a company were used based on future probabilities.

The two valuation methods that came to starkly differing numbers were:

  • Discounted cash flow method (value assuming continued operations) versus the
  • Asset method (liquidating the firm and selling off the assets).

After an appeal up the Ninth Circuit Court of Appeals, the initial tax court assumptions were overturned. The final value was determined at almost $14 million (less than half the initial IRS determination).

Ways to avoid leaving behind tax issues

Placing a family-owned company or vacation home into a trust for the benefit of loved ones can sometimes be a solution. A transfer of assets can often be completed in a more thoughtful manner. A trust may also avoid this type of valuation issue with the IRS and provide you with more control over when the transfer of assets occurs.

While each situation is unique, working with an experienced estate planning attorney can avoid passing a mess to children or grandchildren. When a gift is likely to surpass the federal gift and estate tax threshold, it is extremely important to do the advance planning.