11th Circuit reverses Jelke: Major win for taxpayer on value of imbedded capital gains

BVWireIssue #62-3
November 20, 2007

Last week the 11th Circuit Court of Appeals approved a “dollar-for-dollar” reduction for the entire built-in capital gains tax liability of a minority interest in a closely held corporation, overruling the Tax Court’s prior allowance of only a partial discount.  In Estate of Jelke v. Comm’r (November 15, 2007) the Court reviewed the historical evolution of corporate tax reform and related case law—including the 5th Circuit’s decision in Estate of Dunn (2002)—to come to an accord “with the simple yet logical analysis of the tax valuation issues set forth [in Dunn], providing practical certainty to tax practitioners, appraisers and financial planners alike.”

“The case is a major win for the taxpayer,” comments Will Frazier, who appraised the estate’s 6.44% interest in the original proceedings.  “It should settle, once and for all, the issue on the applicability of the built-in capital gains tax liability in valuing equity in a C corporation.”  After getting a poor result in the Tax Court, “the taxpayers almost did not want to appeal,” he adds.  “Their advisors and I had to beg them.”  They ended up retaining John Porter (Baker Botts) to take on the appeal.  “A good choice on their part.”

The only downside of the case: the Court declined to disturb the Tax Court’s determinations of discounts for lack of marketability (15%) and control (10%). (“These two issues are affirmed without further discussion.”)  In Frazier’s view, this represented another “split the difference” opinion, the federal appeals court deferring to the lower court’s discretion on the discount issue, perhaps in preference for a “bright line” rule on imbedded capital gains.

To read this important case, click here.  The full text of the Tax Court’s 2005 opinion is available to subscribers of BVLaw™ at BVLibrary, which contains a wealth of related materials, including early commentary by Shannon Pratt, and a 2006 teleconference by Pratt, Frazier, Mark Lee and Eric Nath.  You can be sure a BVR teleconference on the new decision and discounting for the value of trapped-in capital gains is in the works.

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