Corporate valuation includes insurance proceeds—In Thomas A. Connelly v. United States (U.S.T.C. 60,737 June 2, 2023), the estate appealed a notice of deficiency concerning a corporate valuation. Michael Connelly died owning 77.18% of a C corporation; his brother Thomas owned the other 22.82%. The brothers had entered into a stock purchase agreement in which the surviving brother had the right to buy out the deceased brother’s shares, otherwise the company would redeem the shares. The agreement provided two methods to determine the value of the company: (1) executing a certificate of agreed value by mutual agreement at the end of every year; or (2) using at least two appraisals of fair market value (FMV). The company obtained life insurance on both brothers.
When Michael died, the company collected the $3 million of life insurance proceeds and redeemed Michael’s shares. No appraisal was obtained. The actual redemption was part of a larger agreement between Michael’s son (who was the personal representative of his estate) and Thomas regarding the estate. On Michael’s estate tax return, the company was valued solely based on the insurance proceeds. The Internal Revenue Service issued a notice of deficiency, asserting that the company had significant value outside of the insurance proceeds, which resulted in higher estate tax.
The estate appealed, arguing that the redemption agreement determined the value of the company for estate tax purposes, so there was no need to obtain an appraisal. In the alternative, the estate argued that the increase to the value of the company from the insurance proceeds would be offset by the redemption liability, leading to the same result.
The district court held for the IRS, and the U.S. Court of Appeals for the Eighth Circuit affirmed. Internal Revenue Code Section 2703(a) requires valuations to ignore options, agreements or other restrictions unless they’re created under a bona fide business agreement with terms comparable to arm’s- length transactions and not a device to transfer property to family members for less than full and adequate consideration. However, the court noted that there was no restriction or fixed or determinable price in the agreement that even applied. The agreement set no particular value or price, and the brothers didn’t follow its methods anyway. Michael’s son, as executor of the estate, had essentially come to a value together with Thomas. The court went on to determine the FMV of the company.
Estate of Blount v. Commissioner (428 F.3d 1338 (11th Cir. 2005), a well-known case in the Eleventh Circuit, already addressed this same issue and held that the proceeds of insurance in a stock purchase agreement that are subject to an obligation for redemption are offset by the liability, so that there’s no impact on the value. However, the Eighth Circuit disagreed with the holding of the Eleventh Circuit in Blount and held that a willing buyer wouldn’t disregard the insurance proceeds that are used to redeem shares because those proceeds do actually increase the value of the company. As a result, it upheld the district court’s affirmation of the IRS.
• Individual retirement account distribution and rollover approved—In a private letter ruling, the IRS again approved of a distribution from an IRA to a surviving spouse to be treated as a rollover without recognizing income and allowed the surviving spouse to treat the resulting IRA as her own (not as an inherited IRA).
In PLR 202322013 (June 2, 2023), a decedent died owning IRAs that named his estate as the beneficiary. The surviving spouse was the executor and sole residuary beneficiary of the estate. She claimed the IRAs as executor, merged them and then distributed the assets to herself. Within 60 days of the distribution, she rolled them into her own IRA.
The IRS confirmed that the proceeds are treated as being distributed directly to the surviving spouse, so that it isn’t an inherited IRA. As the rollover was completed within 60 days, none of the proceeds were included in her taxable income.
• Professional organization denied IRC Section 501(c) status—The IRS denied a professional organization tax-exempt status under Section 501(c)(3) in Letter 4034 (Jan. 11, 2023). The organization was dedicated to educating estate-planning professionals and promoting cooperation among businesses and individuals in the field such as lawyers, accountants, insurance agents and planned giving officers. The IRS noted that the Treasury regulations provide that an organization must be organized and operated exclusively for exempt purposes. To meet that standard, only an insubstantial part of its activities may be outside its exempt purposes. The IRS found that a good portion of the organization’s activities were devoted to social and networking opportunities for its members, which was a private, not public, purpose. This non-exempt purpose drove more than an insubstantial portion of the organization’s activities, and therefore, it wasn’t operated exclusively for exempt purposes.