Archive for June 23rd, 2011

A senior Treasury official announced today that the government is working on a number of guidance projects that will clarify the interplay between the cancellation of indebtedness (“COD”) provisions of Section 108 and the partnership tax provisions of Section 701-777, including:

1. rules on debt-for-equity exchanges under tax code Section 108(e),

2. guidance on the treatment of noncompensatory options, and

3. rules on transactions under Revenue Ruling 99-6 (a partnership converting to a SMLLC), among others.

Joking title aside, the lack of guidance in these areas when compared to the corporate COD rules has made things very difficult for tax practitioners. For example, the increasingly common transaction whereby a debtor partnership issues a partnership interest to settle a debt with a creditor has only recently addressed in Proposed Reg. Section 1.108-8. While these regulations have been helpful, they still leave a host of unanswered questions, and contain ample room for improvement.

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Hot off the presses:

The Internal Revenue Service today announced an increase in the optional standard mileage rates for the final six months of 2011. Taxpayers may use the optional standard rates to calculate the deductible costs of operating an automobile for business and other purposes.

The rate will increase to 55.5 cents a mile for all business miles driven from July 1, 2011, through Dec. 31, 2011. This is an increase of 4.5 cents from the 51 cent rate in effect for the first six months of 2011, as set forth in Revenue Procedure 2010-51.

In addition, the per mile rate is also increased for medical and moving use: from 19 cents to 23.5 cents. The mileage rate for charitable use of  a car is stuck at 14 cents, however.

In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2011. When you’re paying $4.00 per gallon on your way to the beach this summer, remember who loves you.

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More from the world of estate taxation from WS+B expert Hal Terr:

In Estate of Natale B. Giustina v. Commissioner, T.C. Memo 2011-141, the Tax Court used a part cash flow, part asset methodology to determine the date of death value of a 41.128% limited partnership interest included in the decedent’s gross estate.   Although the Tax Court’s valuation was more than 50% higher than the value reported on the estate tax return, the Tax Court found the estate was not subject to the 20% accuracy-related penalty because the estate met the reasonable cause exception.

In 1990, Natale Giustina’s family created the “Giustina Land & Timber Co. Limited Partnership” and transferred their interest in the family timber business to this partnership.   Natale Giustina owned a 41.128% limited partnership interest in the new entity.   At the time of Giustina passing, the value of the timberlands owned by the partnership was agreed to be $142,974,438.  On the estate tax return, the value of the limited interest was reported to be $12,678,117. 

At trial, the IRS argued that  the value of the limited interest was $33,515,000.  The estate and the IRS each had expert witnesses testify to the value of the limited partnership interest.   The Tax Court found faults in each expert’s valuation calculations. 

The court did not agree with the IRS’s determination of the discounted cash flow from the partnership, nor did it agree with the estate expert’s 25% reduction for income taxes when determining the discounted cash flow or the discount rate used.  The estate argued for a 35% marketability discount, but the Tax Court agreed with the IRS expert, and settled on a 25% marketability discount. 

The IRS expert gave a 30% weight to the cash flow method while the estate’s expert applied a 20% weight.  The Tax Court disagreed with both experts and applied a 75% weight to the cash flow method given the higher probability that the partnership would have continued its operations rather than liquidating its assets. 

In addition, the court applied a 25% weight to the valuation of the timberlands.   The result was a limited partnership interest valuation of $27,454,115.

Since the Tax Court’s value of the limited partnership was more the 50% higher than the value reported by the estate, the IRS assessed a 20% accuracy related penalty of approximately $2.5 million.  Under IRC Section 6664(c)(1), no penalty is imposed with respect to an underpayment if there was reasonable cause for the underpayment and the taxpayer acted in good faith.   The Tax Court determined that the penalty should not be assessed since the executor hired an attorney to prepare the estate tax return, a valuation firm to appraise the limited partnership interest and the executor relied on the appraisal in filing the return.  Although the appraisal did not incorporate the asset method, the Tax Court found it was reasonable for the executor to rely on the appraisal and the valuation was made in good faith and with reasonable cause.

 What can be learned from this decision by the Tax Court?   Until legislation is enacted by Congress, the IRS will continue its attack of family limited partnership and the valuation discounts for lack of marketability and control, specifically those partnerships funded with passive assets.   In addition, the decision highlights just the differing views the IRS and the taxpayer often have in valuing the same limited partnership interest.  However, by hiring the right advisors and acting in a diligent and prudent manner, tapayers can avoid application of the 20% accuracy related penalty.

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