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Good news for shareholders in closely-held corporations

Shareholders in closely-held corporations have won an important estate tax battle with the Internal Revenue Service.

The issue is how to place a value on a corporation that has a lot of “built-in” capital gains-meaning that if the company’s assets were liquidated, it would owe a hefty capital gains tax. 

In this case, a man named Frazier Jelke owned about 6 percent interest in an investment company.  The company had $188 million worth of assets.  However, if it sold those assets tomorrow, it would owe $51 million in capital gains tax.

When Jelke died, his family calculated the value of his interest for estate tax purposes.  The family subtracted the $51 million from the $188 million and then figured out what 6 percent of the result was.

But the IRS said this approach was wrong.  Since the company was expected to sell its assets over 16 years, the value of the assets should be figured using the present value of the capital gains liability stretched out over that period, according to the IRS.  Its formula was complicated, but when the dust settled, it wanted Jelke’s estate to pay an additional $2.6 million in estate taxes.

But the federal appeals court in Atlanta sided with the Jelke’s family.  It said the family’s approach was simple and valued the company as an ordinary buyer would value it.  The IRS’s approach, by contrast, was based on “prophecies” about what the company would do in the future.

This ruling only affects traditional “C” corporations and is binding in only a few states, but its still a big victory for taxpayers and might cause the IRS to back off in other cases.

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