Court Values Estate's LLC Interests; Discounts Apply to Split Donation

(Parker Tax Publishing March 2021)

The Tax Court held that it was more appropriate for it to value limited liability company (LLC) interests held by an estate because the IRS and the estate both had shortcomings in their analyses of the value of the LLC interests. Further, the court concluded that it was appropriate to apply a discount to the estate's donation of an LLC interest that was split between two charities. Estate of Warne v. Comm'r, T.C. Memo. 2021-17.

Background

In 1981, Thomas and Miriam Warne created the Warne Family Trust (Family Trust). Over the years, the Family Trust became the majority interest holder of five LLCs, which held ground leases in various properties in California: WRW Properties, LLC (WRW); Warne Ranch, LLC; VJK Properties, LLC (VJK); Warne Investments, LLC; and Royal Gardens, LLC. Royal Gardens was a single-member LLC wholly owned by the Family Trust. Royal Gardens held a leased fee interest in a mobile home park known as Royal Gardens Estate. The value of Royal Gardens was approximately $25.6 million. Miriam Warne, as trustee, served as the managing member of each LLC.

In 2012, Ms. Warne gave fractional interests in the five LLCs to her family members. When Ms. Warne died in 2014, her estate donated her interest in Royal Gardens by splitting the donation between two Code Sec. 501(c)(3) charitable organizations, with 25 percent going to St. John's Lutheran Church and the remaining 75 percent going to a family foundation (Family Foundation).

Ms. Warne's estate timely filed Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The Form 706 listed the following date-of-death values for the Family Trust's majority interests in the five LLCs: $18,006,000 for a 78 percent interest in WRW; $8,720,000 for a 72.5 percent interest in Warne Ranch; $11,325,000 for an 86.3 percent interest in VJK; $10,053,000 for an 87.432 percent interest in Warne Investments; and $25,600,000 for a 100 percent interest in Royal Gardens. On the estate's Schedule O, Charitable, Public, and Similar Gifts and Bequests, the estate listed as charitable donations its 75 percent Royal Gardens donation to the Family Foundation, reported to be worth $19,200,000, and its 25 percent Royal Gardens donation to the church, reported to be worth $6,400,000. Combined, those amounts equal the full value of the 100 percent ownership interest in Royal Gardens that was shown as being included in the estate.

The IRS issued notices of deficiency determining a gift tax deficiency for 2012 and an estate tax deficiency. In calculating the gift and estate tax deficiencies, the IRS determined an increased fair market value of the LLCs on the basis of its valuations of the ground leases. In calculating the estate tax deficiency, the IRS also determined more modest discounts for lack of control and marketability than the estate had used for the remaining LLC interests held by the estate. And the IRS determined that a discount for lack of control and marketability should be applied when calculating the value of the split donation. Finally, the IRS determined a Code Sec. 6651(a)(1) addition to tax of approximately $90,000 for failure to timely file a gift tax return for gifts made in 2012.

The estate took its case to the Tax Court. The parties agreed to apply discounts for lack of control and marketability for the Family Trust's majority interests in the LLCs on the date of death. The estate and the IRS each hired an expert to testify before the Tax Court. The experts drafted reports analyzing the appropriate discounts for each LLC. Both experts generated nearly identical reports for each LLC and concluded the same type of discounts applied to each LLC. Because the LLCs were asset-holding entities, both parties used the adjusted net asset value (ANAV) approach to value the LLCs. The ANAV method calculates the current market value of a 100 percent controlling interest by subtracting the company's liabilities from its assets. However, the experts had different approaches to calculating the discounts.

While the estate's expert concluded that a discount for lack of control of 5 percent to 8 percent should be applied in the valuations of the LLCs, the IRS's expert concluded that a 2 percent discount was more appropriate. The estate's expert determined that an overall discount for lack of marketability was 5 percent to 10 percent for the LLCs while the IRS's expert concluded that a 2 percent discount applied. The two experts each combined their discounts for lack of control and marketability for a final total discount. The estate's expert came up with a 10 percent discount while the IRS's expert determined a 4 percent discount. With respect to the donation of the Royal Gardens interest, the estate argued that because Ms. Warne donated 100 percent of Royal Gardens' value to charitable organizations, a discount should not apply.

With respect to the split donation, both parties cited Ahmanson Foundation v. U.S., 674 F.2d 761 (9th Cir. 1981) for support. In Ahmanson, the decedent owned (through a revocable trust) a corporation that had 100 shares. Only one of those shares was a voting share; the remaining 99 shares were nonvoting. The decedent bequeathed the one voting share to his son and the 99 nonvoting shares to a charitable foundation. The Ninth Circuit in Ahmanson concluded that nothing in the statutes or in the case law suggested that the valuation of a gross estate should take into account that the assets will come to rest in several hands rather than one. The Ninth Circuit concluded that the estate's deduction attributable to the donation of the 99 nonvoting shares necessitated a 3 percent discount to account for the foundation's lack of voting rights.

Analysis

The Tax Court held that, because both parties' experts had shortcomings in their analyses, it was more appropriate for the court to make its own valuations relying on the experts' testimony and underlying data. Likewise, the Tax Court considered the experts' testimony in determining appropriate discounts for the LLCs and concluded that the discount for lack of control was 4 percent. In determining the discount for lack of marketability, the court noted that the IRS's expert provided little information for concluding that a 2 percent discount was appropriate. The court rejected that conclusion and found that a 5 percent discount was more appropriate.

Regarding the split donation, the Tax Court noted that in Ahmanson, the Ninth Circuit found that, when valuing an asset as part of an estate, the entire interest held by the estate is valued without regard to the later disposition of that asset and the value of the property received by the donee determines the amount of the deduction to the donor. The court concluded that it was appropriate to apply a discount to the charitable contribution deduction for the estate's donation of Royal Gardens and that a 27.385 percent discount was appropriate for the 25 percent interest and a 4 percent discount applied to the estate's 75 percent donation to the Family Foundation.

For a discussion of charitable contributions that an estate may deduct, see Parker Tax ¶227,710.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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