The Good and Bad of Estate Tax Planning
The Tom Clancy and Carl Pohlad estates were recently in the popular press, with issues related to transfer tax planning (or lack thereof). As reported on August 24, 2015 in the Wall Street Journal, the headline reads “Tom Clancy’s Widow Wins Legal Battle Over Taxes on $86 Million Estate.” The byline says that the “Judge rules Trust for grown children must shoulder the bill.” The August 30, 2015, Star Tribune reported that the “Pohlad case resolved at a fraction of the original IRS claim.”
Starting with the good, the Minnesota estate tax assessment of $255.8 million against the Pohlad Estate was settled for $36 million after a lengthy battle with the IRS. The Estate retained John W. Porter as lead counsel, an ACTEC fellow from Houston, Texas who is well known for his expertise in handling, among other issues, Family Limited Partnership structures established for estate planning purposes. As an aside, one of the significant advantages has been the use of “discounts” to value the interests being gifted to family members; we expect the Department of Treasury to issue new proposed regulations later this Fall that will reduce or eliminate discounts for certain transfers among family members.
Aside from the discount planning, the Pohlad case also included the market-driven issue of valuing his minority interest in the Minnesota Twins during the Great Recession (what would a willing buyer be willing to pay for the interest when Mr. Pohlad died in 2009). On the planning side, the estate had been designed during lifetime with several business entities owning Mr. Pohlad’s businesses, and then lifetime gifting to his three sons and other beneficiaries in a tax-efficient manner which reduced Mr. Pohlad’s remaining ownership to a minority interest. Upon his death, the estate was entitled to various “discounts” to his minority interest, which are typically based on lack of control and lack of marketability. Such planning has been attacked many times by the tax authorities over the last two decades, but has been upheld by the courts in many cases as a reflection of fair market value, which the Federal law defines as “the price that property would sell for on the open market, and that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.” As an example, valuation discounts are frequently used for publically-traded entities such as Master Limited Partnerships that invest in commercial real estate (the typical “passive” investor will pay less than the percentage ownership of partnership assets being purchased), and historically has resulted in discounts of anywhere from 10%-60%.
The Clancy case illustrates the danger of not addressing “tax apportionment clauses” in estate plans. This is an often overlooked provision in the drafting phase, and can be impacted by the local state statute which operates as the default rule in the absence of more specific direction. The Estate consisted primarily of a minority share in the Baltimore Orioles, and included a rare World War II tank. Because of the way the plan was designed, the Judge ruled that the two-thirds of the estate going to the surviving spouse should not pay any of the estate tax bill, while the other one-third would be liable for the $11.8 million. This portion of the estate had been left to Clancy’s four adult children from his first marriage, and ends up being a 41% tax hit to the children. The Judge ruled that the estate plan essentially was designed to transfer the spousal share with no estate tax, primarily because the Federal Tax Law provides that no estate tax is usually assessed against the portion of the estate (regardless of size) going to the surviving spouse (if a U.S. Citizen). The Judge interpreted the Will to support the intention of transferring assets to his surviving spouse without tax. If Mr. Clancy had intended to share the estate tax among his surviving spouse and children of the first marriage, he could have made changes to the tax apportionment clause in his estate plan.
As mentioned earlier, it is anticipated that the Department of Treasury will be issuing new proposed regulations that will restrict the use of discounts when transferring interests among family members. The regulations will be an interpretation of Internal Revenue Code §2704, and will provide further guidance on if and when discounts can be used for transfers among family members, primarily when the party making the transfer (the “transferor”) retains some interest in the entity.
Contact the estate planning team at Hellmuth & Johnson, PLLC, if you have any questions regarding the issues described in this column, if you are business owner, farmer or real estate owner that wishes to plan in advance for these issues, or if you need any general estate planning assistance.