February, 2007



In TAM 200648028, August 4, 2006, the Internal Revenue Service issued a ruling on, among other things, valuation as affected by a built-in liability. Two things are of note here. One is that the type of tax liability is different from most other cases. Secondly, the Service is intent on getting the likelihood and timing of the realization of that tax liability into the equation of value.


Here, housed under the subheading “Pension Liability,” the Service recited the following reasoning:

In Estate of Jelke v. Commissioner, T.C. Memo. 2005-131, the court considered the extent to which a potential capital gain tax liability (that would be incurred only when the corporate assets were sold) was to be taken into account in determining the fair market value of an interest in a closely held corporation. The court determined that the net asset value of the corporation should be reduced to reflect the liability that would necessarily be incurred when the corporate assets were sold. The Commissioner's expert calculated the appropriate reduction based on projections of when the tax liability would likely be incurred. The court agreed with this approach, and held that, because the tax liabilities are incurred when the property is sold, the liabilities must be indexed or discounted to account for the time value of money. See also, Estate of Dunn v. Commissioner, T.C. Memo 2000-12, rev'd, 301 F.3d 339 (5th Cir. 2002); Estate of Jameson v. Commissioner, T.C. Memo 199943, rev'd, 267 F. 3rd 366 (5th Cir. 2001). In Estate of Dunn, the Fifth Circuit concluded on this point that under an asset-based valuation methodology, the net asset valuation should be reduced for the built-in gains tax liability on a dollar-for-dollar basis and the probability of liquidation was to be considered in assigning relative weights to the asset-based and income-based valuation approaches.

In this case, * * * Co. 1 and the corporate members of the control group may be required to pay the $ AA pension liability at some time in the future. Therefore, this potential liability should be taken into account for valuation purposes. However, a dollar-for-dollar reduction for the $ AA pension liability would not be appropriate if the payment will not be due until some time in the future. Accordingly, if, as of the valuation date, the facts indicated that the liability would not be due and payable for an extended period of time, the $ AA liability must be indexed or discounted to account for the time value of money. See also, Okerlund v. United States, 365 F.3d 1044 (Fed. Cir. 2004) (underlying valuation projections are made using facts known on the valuation date, but post-death events may demonstrate the reasonableness of those projections).


In the cases cited, and others that stem from the Estate of Davis case, the courts were dealing with built-in capital gain tax liability. The courts said that a hypothetical willing buyer would take that potential liability into account. Here, however, the potential liability was an unfunded pension liability. This ruling appears to have indicated a willingness by the IRS to expand the types of taxes to be taken into account in the valuation of assets in a decedent’s estate.


For the IRS, the possibility and timing of the tax liability must be taken into account in an asset-based valuation approach. That much is apparent in this ruling. The Service’s position is bolstered by the Jelke case. Jelke appears to fly in the face of the Dunn and Jameson cases decided by the 5 th Circuit, which say flatly that the existence of the potential tax must be taken into account in an asset based valuation, and the possibility and timing of the tax is not to be considered. In the Jelke case, the Tax Court, after reviewing cases from the 2 nd, 5 th and 6 th Circuits striking down the Tax Court’s determinations of improbability of triggering a tax liability or whether and to what extent it should be considered, said, “We are not bound by or compelled to follow the holdings of a Court of Appeals to which our decision is not appealable.” From that the Tax Court worked out a discounted present value approach to what otherwise was an asset-based valuation.


In the 2 nd Circuit case of Eisenberg v. Commissioner , the court said “ The issue is not what a hypothetical willing buyer plans to do with the property, but what considerations affect the fair market value of the property he considers buying.” Later, the court stated, “We believe that an adjustment for potential capital gains tax liabilities should be taken into account in valuing the stock at issue in the closely held C corporation even though no liquidation or sale of the Corporation or its assets was planned at the time of the gift of the stock.”


Apparently, the Jelke case was not appealed. Attorneys and valuation experts are left to contemplate whether and to what extent timing of a tax liability should be taken into account in asset based valuations. In the 2 nd, 5 th and 6 th Circuits, it appears that answer is no. But elsewhere, there is still an open question.

Jim Roberts


2200 One Galleria Tower

13355 Noel Road, LB 48

Dallas , Texas 75240

Estate of Davis v. Commissioner, 110 T.C. 530, 552-554 (1998); Estate of Welch v. Commissioner, T.C. Memo. 1998-167, revd. without published opinion 208 F. 3d 213 (6th Cir. 2000); Eisenberg v. Commissioner, T.C. Memo. 1997-483, revd. 155 F. 3d 50 (2d Cir. 1998); Gray v. Commissioner, T.C. Memo. 1997-67.

Interestingly, the Service and the Courts seem torn on which way to address these issues. See Shackleford v. U.S., 262 F. 3rd 1028 (9 th Cir. 2001), affirming Estate of Thomas Shackleford v. U.S., 84 A.F.T.R. 2d (RIA) 5902 (E.D. Cal. 1999) which dealt with a lottery prize payable in installments on the basis of a valuation discount.

Jelke dealt with estate of a Florida decedent (11 th Circuit) holding 6.44% of a holding company which held marketable securities, where the turnover in those investments was limited, and holdings tended to be long term. In that case, the Tax Court relied on an expert who, doing an asset based approach, calculated the rate of turnover and discounted to present value the liability that would be incurred from time to time.

In Dunn, the 5 th Circuit left open the use of the likelihood of triggering the tax only when determining the weight to be assigned an asset-based approach in comparison to other approaches.

Eisenberg v. Commissioner, T.C. Memo. 1997-483, revd. 155 F. 3d 50 (2d Cir. 1998)