Estate Tax Deduction for Charitable Contribution Reduced Below Date of Death Value By Subsequent Actions of Family

Victoria Dieringer’s estate plan left her estate, consisting largely of a majority interest of stock in a closely held realty management company, to a trust and a few charitable organizations.  The trust provided that it would distribute the assets it received (which included all of the stock) to a qualified §501(c)(3) private foundation. 

However the IRS objected to the amount claimed as the deduction for the transfer to the private foundation on the estate tax return, arguing that the deduction should be for far less than the value of the stock on the date of Victoria’s death in the case of Estate of Dieringer v. Commissioner, 146 TC No. 8.

Generally, the mere fact that the value of the stock might have decreased from the instant of Victoria’s passing until it was actually transferred into the hands of the charity would not matter.  As the Tax Court notes:

Normally, absent a section 2032 election (ed note: the alternative valuation date election), the date-of-death value determines the amount of the charitable contribution deduction, which is based on the value of property transferred to the charitable organization. See generally sec. 2055(d) (the amount of the charitable contribution deduction “shall not exceed the value of the transferred property required to be included in the gross estate”); sec. 2055(g)(1).

After all, it takes some time for the executor or similar party to actually administer the property in the decedent’s taxable estate and eventually transfer the property to the proper parties.

But the IRS argued that in this case that should not be true, as a number of events took place with regard to the corporation and its stock following her death that the IRS argued effectively the sons had thwarted their mother’s intent to transfer a majority interest to the Foundation—and the Tax Court ultimately agreed despite finding that valid business business purposes existed for the overall actions taken.

Following Victoria’s death, the corporation made an S election (for business tax planning purposes).  At the same time the corporation entered into an agreement to redeem the trust’s stock, eventually redeeming all of its voting shares and a portion of its nonvoting shares and also entered into a stock subscription agreement where the sons purchased additional stock.

The estate claimed that these actions had been taken for valid business reasons, and the Court agrees.  As the Court notes:

The subsequent events do appear to have been done for valid business purposes. Mr. Keepes, a director of DPI and advisory trustee for the foundation, suggested that DPI elect S corporation status in order to avoid the section 1374 built-in gains tax on corporate assets. Additionally, after consulting an outside attorney, DPI believed that a redemption would allow it to freeze the value of its shares into a promissory note, which would mitigate the risk of a continual decline in stock value during the year's poor economic climate. A redemption also made the foundation a preferred creditor to DPI so that, for purposes of cashflow, it had a priority position over DPI's shareholders. Eugene, Patrick, and Timothy purchased additional shares in DPI in order to infuse the corporation with cash to pay off the promissory notes that DPI gave the trust as a result of the redemption.

However, the court had problems with the actual agreements that implemented the redemption, specifically taking issue with the values used for the redemption of the stock.

The estate argued that, in fact, due to the troubled nature of the real estate market in 2009, there had been a substantial decline in value of the stock from the date Victoria died in April until the redemption agreement was entered into in December.  As Eugene (the trustee of both the decedent’s trust and the foundation) noted:

Eugene testified that the drop in the value of the DPI shares was the result of a poor business climate. Eugene described DPI's experience as “not a fun time to go through” because the real estate market values were declining. Specifically, Eugene explained that DPI's commercial tenants were requesting rent relief and that vacancies in DPI's residential portfolio were increasing “because of people moving [in] with families or friends consolidating.”

However, the Court found that this did not explain the full differences.  Specifically, the Court noted that while the original valuation of the shares prepared for the estate tax return did not include a discount for lack of control or lack of marketability given that the interest being transferred was a majority interest.  However, the valuation used for the redemption agreement included both a 15% discount for lack of control and a 35% discount for lack of marketability.

As the Court notes:

Even though there were valid business reasons for the redemption and subscription transactions, the record does not support a substantial decline in DPI's per share value. Eugene testified that the precipitous drop in the value of the DPI shares was the result of a poor business climate. The evidence does not support a significant decline in the economy that resulted in a large decrease in value in only seven months. The adjusted net asset value of DPI was only $1,618,459 higher in the April appraisal. The reported decline in per share value was primarily due to the specific instruction to value decedent's majority interest as a minority interest with a 50% discount.

The fact that 2009 was a bad time isn’t the issue—rather the issue was whether things really became that much worse from April of 2009 (when things were already fairly bad in the real estate market readers may recall) and November of that year.

Ultimately the Court found:

We do not believe that Congress intended to allow as great a charitable contribution deduction where persons divert a decedent’s charitable contribution, ultimately reducing the value of property transferred to a charitable organization. This conclusion comports with the principle that if a trustee “is empowered to divert the property * * * to a use or purpose which would have rendered it, to the extent that it is subject to such power, not deductible had it been directly so bequeathed * * * the deduction will be limited to that portion, if any, of the property, or fund which is exempt from an exercise of the power.” Sec. 20.2055-2(b)(1), Estate Tax Regs. Eugene and his brothers thwarted decedent’s testamentary plan by altering the date-of-death value of decedent’s intended donation through the redemption of a majority interest as a minority interest.

The trust did not transfer decedent’s bequeathed shares nor the value of the bequeathed shares to the foundation. Accordingly, we hold that the estate is not entitled to the full amount of its claimed charitable contribution deduction. Respondent’s determination is sustained.

The case mainly serves as a cautionary tale about taking too much comfort in having a “valid non-tax purpose” for a transaction.  The brothers had valid reasons for doing what they did—but they were tripped up when they sought a valuation to justify a price for the redemption that was significantly less than the value that had been determined just a few months earlier. 

The Court was clearly troubled by the introduction of significant discounts in the second valuation even though it was arguably the same asset being valued as had been valued earlier—and the Court didn’t buy any explanation for the change in methodology.