Estate Planners Gain Precedent on Passthrough Valuation Maneuver

Jan 27, 2020 | Estate Planning, Taxation

Estate planners should heap praise on a recent Tax Court holding that cracked open a door on a technique long viewed as sealed shut on allowing taxpayers to discount earnings from a passthrough entity.

Estate Planners Gain Precedent on Passthrough Valuation Maneuver - by Jonathan Curry - Hosted by ALI CLE
Estate Planners Gain Precedent on Passthrough Valuation Maneuver – by Jonathan Curry – Hosted by ALI CLE

The Tax Court held August 19 that the taxpayer could tax affect the earnings from an S corporation and a limited partnership when valuing the business interests for gift tax purposes. That, in effect, allowed the taxpayer to reduce the value of the earnings from his passthrough entities by an assumed corporate tax rate, a method the IRS has historically taken a hard stance against.

“This is a truly groundbreaking decision in the valuation world and for most estate planners,” Stephanie Loomis-Price of Winstead PC said of the holding in Estate of Aaron U. Jones (T.C. Memo. 2019-101).

“What we have in the Jones case is . . . a Tax Court judge who looked at the facts, looked at the law, and has come to a rational conclusion with regard to tax affecting,” Loomis-Price said October 25 at an estate planning conference hosted by the American Law Institute in Phoenix. “It’s wonderful to finally have a bit of jurisprudence that seems to understand the need for tax affecting,” she added.

Cracking the Iceberg

Loomis-Price noted that, starting with Gross v. Commissioner, T.C. Memo. 1999-254, in the 1990s, the Tax Court has consistently held that taxpayers couldn’t tax affect earnings from their passthrough entities.

Loomis-Price, a litigator, recalled that an IRS official involved in policy told her there was no official policy saying that taxpayers couldn’t apply tax affecting, but rather that the government was just very selective about when it could be applied. Despite that, Loomis-Price said that “every examining agent and every valuation engineer I work with says it is a hard and fast rule.”

Before the Jones holding, another case presented a “chip in the iceberg of the tax affecting world” — the district court case of Kress v. United States, No. 1:16-cv-00795, (E.D. Wis. 2019). In that case, a Wisconsin federal district court held that tax affecting was appropriate, in part, perhaps because experts for both the IRS and taxpayer used tax affecting in their approach, Loomis-Price said.

Kress was “certainly something to get excited about,” but because it wasn’t decided in the Tax Court, “it wasn’t really something that we could rely on; we could just cite to it and hope that someday we might get a crack in that iceberg,” according Loomis-Price.

Best Case Ever

Then came the Jones holding in August — “a very, very strong and wonderful, fabulous case,” Loomis-Price said.

In siding with the taxpayer’s expert appraisal, the court indicated that their use of tax affecting may not have been perfect, but it was better than the IRS’s position that no tax impact should be considered, according to Loomis-Price. That signaled that “we’re going to continue seeing case law develop on this issue,” she added.

The court further indicated that previous cases involving tax affecting were fact-based, and thus the court didn’t intend to overturn those decisions. Rather, the court was recognizing that the facts support the tax affecting method used by the appraisers in this particular case, Loomis- Price said.

Loomis-Price further noted that the appraisers used a tax affecting method called the S Corporation Economic Adjustment Model, which she said is “now going to be our Excalibur when it comes to tax affecting.”

The Tax Cuts and Jobs Act revealed Congress’s desire to try to equalize the tax treatment of passthroughs and C corporations, and Jones is a “first humongous step” toward finding a way to treat S corps and other passthrough entities similarly to C corps, according to Loomis-Price.

“We’re now starting to see the case law develop in the same ways,” she said.

This article was written by Jonathan Curry and originally published by Tax Notes. To learn more about the author and Tax Notes, please visit