Estate of Elkins: Fifth Circuit Reverses the U.S. Tax Court and Upholds the Fractional-Ownership Discount
Joseph D. Brophy, MBA, CPA/ABV, CVA, ABAR, CM&AA
On September 15, 2014, the Fifth Circuit ruled in favor of the Estate of James A. Elkins seeking a $14.4 million refund for estate taxes claiming that the fractional-ownership discount advanced was improperly rejected.
In the Estate of James A. Elkins, Jr. (deceased); Margaret Elsie Joseph, and Leslie Keith Sasser, Independent Executors v. Commissioner, No. 13-60472, the question before the court was primarily whether a Tax Court decision against the estate should be upheld or the petitioners granted relief.
Decedent and his wife during their lifetimes owned numerous valuable artworks, which they retained either individually or held in a Grantor Retained Income Trust or GRIT (trust) for their benefit during their lifetime. Upon the death of the second to die, Mr. Elkins, the estate claimed a 44.75 percent discount on the art because the decedent owned a fractional interest.
Decedent and his wife created a GRIT for three of the art pieces, which provided that upon the wife’s death, their three children would receive title to her 50 percent and the husband would retain his 50 percent interest in the trust.
Husband disclaimed some rights in other art, which further reduced his ownership. He gifted a minority interest in the art to their children during life, but the “decedent owned at his death an aggregate 73.055 percent interest in each of those 61 pieces (the disclaimer art) comprising his original 50 percent and the 23.055 percent interest from his wife’s bequest that remained after deducting the 26.945 percent interest that decedent disclaimed” on his wife’s death.
The IRS and the estate agreed in the Tax Court case as to the value of 64 art work pieces, which were appraised by Sotheby’s.
Deloitte, LLP, was retained by the estate to provide a report for use by the estate, which is mentioned in the Fifth Circuit decision. Presumably the report concluded the valuation discount should be 44.75 percent.
The Tax Court accepted the valuation of the art, but concluded without further evidence a discount should be applied even though the commissioner argued none should apply. The Tax Court selected a 10 percent discount ‘based on the preponderance of the evidence,” but the Fifth Circuit concluded the only evidence in the record was the report provided by the estate and the “preponderance of evidence” standard did not apply.
The Fifth Circuit concluded the evidence offered by the estate was credible and that the Tax Court could not without expert testimony conclude the 10 percent discount was more reasonable. Specifically, it concluded that:
[W]e (1) affirm the Tax Court’s rejection of the Commissioner’s insistence that no fractional-ownership discount may be applied in determining the taxable values of Decedent’s undivided interests in the subject art work; (2) affirm the Tax Court’s holding that the Estate is entitled to apply a fractional-ownership discount to the Decedent’s ratable share of the stipulated FMV of each of the 64 works of art; (3) reverse the Tax Court’s holding that the appropriate fractional-ownership discount is a nominal 10 percent, uniformly applied to each work of art, regardless of distinguishing features; (4) hold that the correct quantums of the fractional-ownership discounts applicable to the Decedent’s pro rata share of the stipulated FMVs for the various works of art are those determined by the Estate’s experts and itemized on Exhibit B to the Tax Court’s opinion; and (5) render judgment in favor of the Estate for a refund of taxes overpaid in the amount of $14,359,508.21, plus statutory interest in the sum to be agreed upon by the parties…
As for the 10 percent discount the U.S. Tax Court used, the Fifth Circuit held that “there is no viable factual or legal support for the court’s own nominal 10 percent discount.” The Fifth Circuit added that “This is particularly ironical when viewed in the light of the Tax Court’s correct distinction of this case from, among others, Estate of Scull v. Commissioner, 67 T.C.M. (CCH) 2953 (1994), and Stone v. United States, No. 06-0259, 2007 WL 2318974, at *3 (N.D. Cal. Aug. 10, 2007). The courts in both of those cases awarded nominal discounts, but as the Tax Court noted, they were only awarded “because of a lack of proof by the taxpayer] that any greater discount was warranted.” But the exact opposite situation is present here…”
For those wanting to read the case, the link is http://www.ca5.uscourts.gov/opinions%5Cpub%5C13/13-60472.0.pdf
Reprinted from the October 23, 2014, QuickRead issue with permission from the National Association of Certified Valuators and Analysts™ and the Consultants’ Training Institute™.
Joseph D. Brophy, MBA, CPA/ABV, CVA, ABAR, CM&AA, is a former member of the AICPA IRS Practice and Procedures Committee and former chair of the Texas Society of CPAs’ Relations with the IRS Committee. He is frequent writer for tax and valuation publications. He can be reached at email@example.com or (214) 522-3722.