The recent holding from the US Tax Court in the case of Estate of Helen P. Richmond, T.C. Memo. 2014-26, sheds light on a couple of points to be aware of when your estate plan includes the use of a family business entity. The primary problem was the Estate’s use of a deficient valuation to determine the value of its interest in the family holding company for purposes of the estate tax return (IRS Form 706).
The estate made the mistake of using an accountant who was not a certified appraiser, which is not per se troublesome, but in this case the result was that the valuation was insupportable. Unfortunately for the estate, the Court found the accountant’s use of the capitalization of dividends method for valuing stock held by the company to be inappropriate. This fact was further exacerbated by the estate’s use of a different expert who used a different valuation method in the court proceedings, and whose valuation more closely resembled that of the IRS.
Ultimately, the Tax Court found that the stock in question had been significantly undervalued (greater than a 65% difference) and, thus, imposed penalties for the estate’s lack of reasonable cause and good faith in submitting an insupportable return.
What can be learned from this case? First, it usually doesn’t pay to take an aggressive discount unless there is a very good reason for doing so. If you are going to take a deep discount on an asset, make sure the appraisal is performed by a qualified professional who uses generally accepted business valuation principles and procedures. Doing so may make all the difference.
Another pitfall to avoid when planning with family business entities is choosing the wrong entity type. For example, in Texas, many practitioners favor the limited partnership (LP) over the limited liability company (LLC) because of the LP’s exemption from the annual franchise tax imposed on the LLC and other business entity types. The key here is to ensure the LP remains a ‘passive’ entity, as defined by Texas Tax Code Rule 3.582.
Because laws and circumstances change frequently, it is never a bad idea to have a qualified professional review your existing family and/or business entities. The professionals at Kearney, McWilliams & Davis routinely assist clients in correcting deficient entity structures, remedying problematic filing issues, and shoring up asset protection features of those structures. If you would like a complimentary review of your family and/or business structure, contact us at (713) 936-9620.