partnership interest where the payments are contingent on income or cash flow to elect to have the payment treated as a QFP.
Parent owns 30% of the preferred and 30% of the common.
The rest of the common and preferred is owned by
nonfamily members. Parent gives 10% of common to child.
Preferred is a non QFP. What is the amount of the gift?
SUGGESTION: value corporation as a whole; subtract 70%
of the preferred at its fair market value; take 10% of
the result. Note this is not 10% of the value of the
corporation as a whole, as that would disregard the
nonfamily preferred. I believe the current statute is
reasonably clear on this point.
Parent owns 30% of the preferred and 30% of the common.
The rest of the common and preferred is owned by
nonfamily members. Parent gives 10% of common to child.
Preferred is a QFP. Dividend is missed on preferred.
What is the amount of the gift? SUGGESTION:
purpose of the deemed gift rule is to protect the
valuation on the gift and thus should be considered in
the same manner as if the preferred was not a QFP. The
failure of the parent to receive the gift on the
preferred benefits all common stockholders. Thus the
gift is 10% of the amount of the preferred dividend not
received by the parent or 3% of the total corporation's
preferred. The statute is not clear as to how one deals
with the deemed gift.
Grandparent held cumulative preferred from grandfathered
recap and parent held common. Grandfather dies leaving
preferred to parent. Parent gives preferred to child A
who needs income and pays gift tax. Later parent gives
common to child B active in business. Child A refuses
to consent. Parent pays gift tax on entire value of
corporation even though parent previously paid gift tax
on preferred stock. SUGGESTION: The extent of the
gift of the common should be reduced by the value of
the prior gift of the preferred. Cf. Section 2701(e)(1).
Corporation recapitalizes with parent taking preferred
stock with compound cumulative dividend at market rate
based on liquidation value of $1,000,000 and common
stock; corporation is worth $1,400,000. Common stock
is given to child. Dividends are not paid. Dividends
compound to give preferred liquidation amount at time
of death of parent of $3,000,000. Corporation's total
value at time of parent's death is $2,200,000. It is
unclear how the value at date of death would be deter-
mined under Sec. 2701(d)(2). The rules under Sec.
2701(a)(2)(B) do not value the liquidation right but
the right to dividends. If it is just dividends in the
future the value is $1,000,000. If it also includes
dividends in the past it would be $3,000,000. The value
without the special rules would presumably be $2,200,000.
There is no justification for valuation above total
market for the corporation. Note that the 20% rule
assures that the taxpayer has been adversely affected
under this ineffective freeze. SUGGESTION: Valuation
increase under Section 2701(d) cannot increase value
above market value of entire corporation. Legislative
history should make clear that QFP includes past unpaid
cumulative dividends.
Parent dies holding preferred stock with a QFP that is left to a QTIP trust for spouse. There is a possible argument that Section 2701(d)(3) makes the spouse the transferor and thus the transfer to the QTIP trust is subject to the statute treating the spouse as if the spouse transferred to the QTIP which is nonqualifying and thus a transfer to the remainderman. SUGGESTION: Insert before "treated" in line five the word "thereafter".
The application of Section 2701(d) (5) is unclear. What
is being transferred needs to have more definition.
it the value immediately before the termination?
does the termination event effect the value? If
the transferor retained the right to an annuity
payment for 10 years and then in the 10th year it
terminates, does the section have some application? In
the case of a preferred that is a QFP, if after five
years the preferred is called, how does it apply? Is
the value of the preferred before the call considered
(which would be the future value of the dividend stream)
and compared to the amount paid for the preferred? If
interest rates had changed so the dividend payment was
above market, the value of such dividend payments could
exceed the call price; is this intended to be a gift?
If so, it seems unjustified as arm's-length parties
would call the preferred in such circumstance.
SUGGESTION: This provision should be eliminated.
not eliminated, it should be clarified as to what is
intended.
11. A corporation has a value of $1,200,000; parent retains $800,000 of cumulative preferred and gives away common. A year later the corporation is in financial difficulty and a loan of $300,000 is made to the corporation by parent for five years at market interest rate. The next year parent makes a $500,000 loan on similar terms. No dividends are paid on preferred. Corporation has no other creditors and asset value is $600,000. Corporation is insolvent and there is no reason to make the failure to pay preferred a gift to common. Failure to pay interest should not be a gift (presumably this is not a problem because of compounding). What is effect on liquidation? Does $2701(d)(5) mean that the value of the preferred and debt is treated as a gift as if the payments would all be made? SUGGESTION: In measuring insolvency, transferor debt should be considered. Eliminate $2701(d)(5).
Buy-sell agreement was entered into between parent and
child A with respect to their stock in a corporation
they owned. The price was to be determined by a formula
based upon an average of the last three years' earnings
times a multiple of 8. Earnings had normally increased
a little more than the inflation rate each year.
agreement was entered into 10 years prior to death of
parent and never reviewed. Multiples in the industry
had moved to 12 four years prior to death. Buy-sell
agreement provided for payments over 10 years with
interest. Buy-sell value of parent share of corporation
is $2,000,000, the appraisal value is $3,000.000.
Parent had an estate plan leaving property all to child
B as child A had received gifts in corporation during
lifetime. Child B hates child A and believes child A
was always favored. Now child B must pay tax on property
going to child A. SUGGESTION: Impose no new limits on
buy-sell agreements. If this is not satisfactory,
impose tax on purchaser of stock.
A buy-sell agreement was reviewed within three years of death and was reasonable at that time. The purchase was made by the corporation pursuant to the buy-sell agreement and the corporation immediately sold it at the same price to unrelated employees. The buy-sell agreement does not set the price as there was a sale to an unrelated party within six months. Section 2702(b)(3). SUGGESTION: Provide for an exception to the six month sale rule for sales at the same price or pursuant to the same formula as contained in the buy-sell agreement. 14. Corporation has only common stock, 20 shares owned by parent, 30 shares owned by child, 50 shares owned by others. Buy-sell agreement with corporation which provides that stock is to be purchased at a formula price. Formula price is $10,000 a share fair market value is $16,000 a share. Buy-sell agreement does not qualify to determine value. It would appear that the stock is valued at $3,200,000 resulting in an increase in value above the buy-sell agreement of $1,200,000 even though the benefit to the child is 30/80. SUGGESTION: Impose no new limits on buy-sell agreements. If this is not satisfactory, impose limits only when the other family members receive over 50% of the benefit. If neither of these alternatives are satisfactory, have the increase in value limited to the benefit to family members.
Section 2703(a)(2) treats any person as a member of the transferor's family if the transfer would otherwise be considered a gift. SUGGESTION: Charity should be eliminated from this definition. Otherwise the gift of income to charity for 10 years, remainder to the donor would result in the entire value of the property be deemed to go to charity. All of the limitation of annuity and unitrust in limiting the charitable deduction would be eliminiated (or at least made inconsistent with this chapter--presumably this chapter overrides provisions in Chapter 11, 12 and 13).
16. Section 2703(a)(2) treats any person as a member of the transferor's family if the transfer would otherwise be considered a gift. It is unclear for what purposes this applies: e.g.:
a. If parent has preferred and common and gives common to niece statute applies.
If parent has QFP preferred and gives common to
niece and dividend is not paid presumably statute
applies to impute a dividend.
If parent gives in year one a car (a cut glass bowl,
a watch, a savings bond) to niece and in year two
sells (or the corporation sells) niece common stock
for full and adequate consideration, does the statute
apply?
SUGGESTIONS: Section 2703(a)(2) should treat a nonfamily member as a family member only for purposes of the particular gift and the deemed gift consequences that subsequently flow from it not, as if, there had been a permanent adoption. Applying the statute to a situation as in (c) would place a heavy burden in normal transactions to determine all past
possible gifts and can be reduced to the ridiculous as the cut glass bowl example illustrates.
Parent and child make a joint purchase of income
producing real estate. The purchase price is $1,000,000.
The tables provide the parents value to be $600,000 and
the child's value is $400,000. The application of
Section 2703 (d) (2) is unclear. Under the most extreme
reading the parent is deemed to have acquired it for
$1,000,000 and transferred the interest to the child.
The parent's interest not being a QFP would mean the
parent was deemed to make a $1,000,000 gift. Further-
more, such gift could cause the property to be included
in the estate under Section 2036(a) or $1,000,000 could
be taxed as a gift and $1,000,000 included in the estate
when the parent only spent $600,000 and received a life
estate. SUGGESTION: The amount of transfer should be
reduced by the consideration paid by the transferee.
The recasting of the transaction as a purchase of the
entire property and a gift should only apply for
purposes of Chapter 14 so that Section 2036(a) does not
apply. Chapter 14 or Section 2036(a) should apply but
never both.
Parent and child purchase property as joint tenants with rights of survivorship. Is this a gift of the entire amount to the child? The issue is whether or not the parent has a life interest. Section 2703(d) (3) State laws vary in this regard and some treat it in such a manner. SUGGESTION: Create an except for joint tenancy with right of survivorship.
TESTIMONY OF JERE D. MCGAFFEY
ON BEHALF OF THE SECTION OF TAXATION
AMERICAN BAR ASSOCIATION
"Discussion Draft" relating to
Estate Valuation Freezes
House Ways and Means Committee
April 24, 1990
The following are situations which the statute probably intended to cover but we believe should not be covered:
Business is a retail concern operated in a corporation
with real estate rented from shareholder. Parent owns
all the stock of the corporation and real estate.
Parent is retiring from business, child is to operate
business. Parent gives all of the stock to child.
Lease on real estate is based on a percentage of
receipts. Leases are considered an interest in the
corporation and the lease is not a QFP. Presumably
this would mean that the valuation of the corporation,
if based on earnings, has to be adjusted by eliminating
any rental expense and, if valued based on assets,
presumably the real estate is included for at least the
period of the lease. What if the lease is automatically
renewable for year-to-year? Unless the parties give
notice of termination, what is the value included? A
percentage lease in such circumstances is the norm. In
fact any other type of lease might be considered not at
arm's-length and involve a gift under other sections of
the code. It is difficult to understand what type of
lease could involve the valuation abuses that are of
concern. It is hard to imagine any discretionary rights
in a lease. Percent of sales rent is a right that
should be valued in the case of a lease. SUGGESTION:
Leases should not be considered an interest in the
entity. If considered, the payment stream, however
contingent, should be an amount that can be elected as
a QFP.
Business is a retail concern operated in a corporation,
all owned by parent. Parent leases space from third
party with contingent rental based on sales.
of importance as a tenant parent receives a 10% interest
in the real estate. Parent gives some of common stock
to child. Presumably 10% of the real estate adds to
the value. SUGGESTION: Lease should not be considered
an interest. If considered, the ownership requirement
in the property leased should have to be at least as
great as the transferor's ownership interests in the
entity.
Business is a retail concern operated in a corporation
owned by child. Third party leases real estate to
corporation with a rental based on sales. Parent buy's
real estate from third party and continues prior lease.
Treated as a gift by parent of real estate to child.
SUGGESTION: Lease should not be considered an interest.
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