Valuation of Remainder Interests
Federal estate tax law is well settled in holding that property transferred
by a grantor during his or her lifetime may nonetheless be subject to estate
tax if certain property rights are retained. However, IRC Section 2036(a)
allows the value of a remainder interest to be excluded from a decedent's
gross estate for estate tax purposes if a bona fide sale for full and
adequate consideration has occurred.
Historically, determining what constitutes a sale for full and adequate
consideration has been the subject of much controversy. Valuation experts
and courts typically encounter this issue when a decedent's gross estate is
subject to and, therefore, is being computed for federal estate tax.
The rationale for allowing the sale of a remainder interest to escape estate
inclusion, as held in Estate of Frothingham v. Comm’r (60 TC 211 (1973)), is
that the size of a decedent's gross estate is not diminished in a situation
where the transferor receives full value for the property transferred.
However, where the remainder interest is transferred for less than adequate
and full consideration, the full value of the property transferred is
includable in the transferor’s estate.
The D’Ambrosio Decision
A landmark case helped clear up uncertainties in the valuation landscape by
holding that the consideration received in exchange for the sale of the
remainder interest need not equal the value of the entire property, as had
been the case for years, but merely that of the remainder interest. The
Third Circuit in D’Ambrosio v. Comm’r (CA-3, 11/26/96, cert. denied, 520
U.S. 1230 (1997)) held that the consideration received in the simple sale of
a remainder interest is adequate where the consideration equals the
actuarial value of the remainder on the date of sale.
The facts in that case centered on the decedent’s having owned one half the
preferred stock in a closely-held corporation. Upon attaining the age of 80,
she had transferred her remainder interest in the stock back to the company
in exchange for an annuity in an amount equal to almost $300,000 per year.
The annuity was worth in excess of $1.3 million, the value of the remainder
interest in the stock at the time of the sale. The decedent had retained her
income interest in the shares of stock. She died three years later, having
received only two annuity payments totaling approximately $600,000. The
stock’s value at that time was $2.35 million. The Tax Court (105 TC No. 18,
4/4/2007) held that the full value of the stock, minus the value of the
annuity, was properly includable in the decedent’s estate.
The Third Circuit disagreed and rejected the Tax Court’s position. Instead,
it held that the decedent’s estate did not have to include any stock value
because she had sold the remainder interest for adequate and full
consideration. If the full value of the stock at the time of death had been
brought back into the estate, the court explained, the post-sale
appreciation of the transferred property would be taxed at death, imposing a
double tax.
Other federal circuit courts of appeals have also transitioned from the
requirement of mandating full consideration for the entire property to that
of the remainder interest. Wheeler v. U.S. (116 F.3d 749, CA-5, 1997)
followed the D’Ambrosio rationale of “full consideration.” And, in Estate of
Magnin v. Comm’r (184 F.3d 1074, CA-9, 1999), the Ninth Circuit, in
reversing one of its own decisions, also adopted the same position.
The valuation of a remainder interest for federal estate tax purposes is a
complex matter. If you and your clients are dealing with such issues, rely
on a valuation expert to persuasively posture your valuation argument. Our
firm can be of assistance. Please
contact us.
This newsletter is provided by
Somerset for our clients and other interested persons upon request.
Since technical information is presented in generalized fashion, no
final conclusion on these topics should be made without further review.
For additional information on the issues discussed, please contact
Steve Riddle,
Tom
Thieme,
Rex Collins or
Doug
Ayres
of our
Litigation & Valuation Team.
This document is not intended or written to be used, and cannot be used,
for the purpose of avoiding tax penalties that may be imposed on the
taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com
