Florida Banking March 2024

January – July, Yr 2: Actively looking to sell, Company hires investment bankers and receives tender offers from five potential buyers. July, Year 2: Three days after receiving the offers, shareholder funds a GRAT using Year 1 409A value. Dec. 31, Year 2: 409A value doubled. Pre closing: Taxpayer funded a charitable remainder trust and used valuation based on the tender offer price. Year 4: Merger closed at four times Year 1 409A valuation. The IRS audited the GRAT and argued that the shareholder did not use a proper gift tax valuation when funding shares into a GRAT. Seeking internal guidance, the matter was referred to the Chief Counsel’s office. Guidance from the office, referred to as a Chief Counsel Advisory (CCA), is not dispositive of the matter nor is it binding precedent. However, it provides the auditor and the taxpayer of the position the IRS likely would take should the matter be litigated. The Chief Counsel was impressed, to the detriment of the taxpayer, by the position that no separate valuation was needed because, according to the taxpayer, business operations had not meaningfully changed in the seven months between the 409A valuation and the funding of the GRAT. The CCA notes, however, that much had changed. The company had hired two investment bankers to market the firm and three days before funding the GRAT, the company had received offers from five different potential buyers, each in the multi billion dollar range. Generally, when advisors contemplate valuation issues for GRATs, they have a sense of confidence in the regulations that suggest if a value is inaccurate, the annuity simply is adjusted to reflect the proper valuation. The trust is to pay to the recipient, in the case of an undervaluation, or be repaid by the recipient, in the case of an overvaluation, an amount equal to the difference between the amount the trust should have paid if the correct value were used and the amount the trust actually distributed (Treas. Reg. 1.664-2(a)(iii)). In fact, GRAT regulations require language in the GRAT trust agreement to this effect (Treas. Reg. 25-2702(c)(2)). A valuation of property for Federal transfer tax purposes generally is made as of the valuation date without regard to events happening after that date ( Ithaca Trust Co. v. United States, 279 U.S. 151 (1929)). While the company eventually was sold to one of the offering firms, closing did not occur until after the GRAT term had expired. Still, the IRS seemed displeased that the ultimate price was billions of dollars and more than four times the original value. It concluded that the 409A valuation was outdated and misleading. Because the annuity was “34 cents on the dollar” and held back “tens of millions,” the CCA said the annuity did not qualify under Section 2702. The resulting operational failure caused the entire funding value of the shares transferred into the GRAT to be Five Lessons, Continued on page 20

At trial, the parties agreed to a $3.1 million valuation of the shares in the estate and proceeded on the merits of the insurance. Both also agreed that the $500,000 added to capital increased the value of the company, but disagreed on whether the balance of the death benefit did. The positions were set: the taxpayer argued no, so the company was worth $3.86 million; the IRS said yes, so the company was worth $6.86 million. The taxpayer had several precedents from other Federal circuit courts as support. In 2005, the 11th Circuit Court (Alabama, Florida, and Georgia) held insurance owned by company is an asset that is offset dollar-for-dollar by the contractual liability to redeem the shares, zeroing it out ( Estate of Blount, 428 F.3d 1338 (11th Cir. 2005)). In 1999, the 9th Circuit Court (Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington) determined that the purchase of a deceased’s stock in an incorporated law firm was an offset by the obligation (the rest was deemed compensation based on the terms of the agreement). Estate of Cartwright, 183 F 2d 1035. But in 2023, the 8th Circuit Court (Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota) in Connelly rejected that argument and included the death benefit in valuing the company with no offsetting liability. This was a victory for the IRS. This leaves a split in the Federal circuits, which is one of the pathways to the U.S. Supreme Court. Of course, we do not see a significant number of Supreme Court cases in the estate, tax and trust planning field, so this is a topic perhaps worthy of monitoring as well as the more relevant lesson that of the IRS position and willingness to litigate their stance. Appraisal Frugality Doesn’t Pay In planning, one can be “penny wise but pound foolish,” and this rings especially true when it comes to valuations. It is understandable that business owners can be hesitant to embrace the need for an additional appraisal and its concomitant effort and expense. In fact, those companies with a non-qualified deferred compensation plan, known as a 409A plan, already are required to obtain an annual appraisal. It can be difficult to appreciate the nuance between appraisals and valuations for different purposes, let alone different tax purposes. Thus, it can be tempting for a business owner to seek to use one valuation for both purposes, but as this CCA demonstrates yet again, this is a mistake that can be tax costly. Just as in the charitable deduction cases, the need for a proper gift tax valuation is unavoidable and applies when implementing estate tax planning techniques. In this matter, the Chief Counsel focused on the failure to obtain a proper appraisal. Some relevant facts: December 31, Yr 1: Company obtains annual 409A valuation.

WWW.FLORIDABANKERS.COM MARCH 2024 — 19