The Internal Revenue Service fired the first shot in March, when it announced its decision not to acquiesce in the Tax Court’s ruling in Kohler v. Commissioner (see BVWire™ #66-2).  The second shot came last Friday, when the IRS published new rules in the Federal Register that would permit estates to elect the alternate valuation date (per §2032(a) and Form 706) only when market conditions and not “other post death events” have reduced the gross value of the estate.

The Service points to §2032’s legislative history as well as conflicting court decisions to explain its proposal.  Congress enacted the predecessor to §2032 after the Depression, when market values decreased so materially from the date of death to the date of distribution that at times, “many estates were almost obliterated by the necessity of paying a tax,” the IRS says.  Since then, two cases have interpreted the provision differently.  In 1972, a federal district court in California excluded any reduction in an estate’s value that resulted from the trustee’s “voluntary acts.”  But in 2006, the Kohler decision permitted the Tax Court to consider a post-death reorganization of the company that resulted in discounts (due to transfer restrictions) on the value of the estate’s stock holdings.  To resolve the apparent conflict, the IRS now seeks to amend §2032(f) so that only “market conditions” will make the alternate valuation date available:

The term market conditions is defined as events outside of the control of the decedent (or the decedent's executor or trustee) or other person whose property is being valued that affect the fair market value of the property being valued.  Changes in value due to mere lapse of time or to other post-death events other than market conditions will be ignored in determining the value of decedent's gross estate under the alternate valuation method.

Would the Kohler outcome be any different?  In its factual findings, the Tax Court noted several legitimate corporate reasons for the Kohler Company’s reorganization, including removing outside shareholders and keeping the longstanding private company within the family’s control.  The estate—which owned 12.5% of the voting stock, “could not have blocked or approved the reorganization on its own,” the court said.  Nor did it have the power to change management, the board of directors, or the company’s articles of incorporation.  While the Tax Court did not specifically find that the reorganization was a corporate event—if it was beyond the estate’s control, then would the market value of the estate’s shares necessarily reflect the resulting transfer restrictions, no matter the valuation date?  For example, the date of death would reflect the expectation that the reorganization would take place, while the alternate valuation date, six months later, would reflect the actual restructuring.  Comments to the IRS proposed rules are due July 24, 2008; see the Federal Register excerpt for instructions and addresses.  The full-text of the Kohler opinion is available to subscribers of BVLaw™.