Charitable Estate Tax Deduction for LLC Membership Interests Reduced by Discounts for Lack of Marketability and Control

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By: Keirsa Johnson, Hemenway & Barnes LLP

Warne v. Commissioner, T.C. Memo 2021-17, United States Tax Court

Background

Miriam Warne owned ground leases on several properties in California, which she and her late husband held through five separate LLCs.  Prior to her death, Miriam transferred fractional interests in four of the five LLCs to her children and grandchildren but retained 100% ownership over Royal Gardens LLC (“Royal Gardens”) through her revocable trust.  Upon her death, Miriam left 75% of her interest in Royal Gardens to the Warne Family Charitable Foundation (“Foundation”), and the remaining 25% to St. John’s Lutheran Church (“Church”).

On the timely filed Form 706, the estate reported the date of death value for Warne Family Trust’s 100% ownership interest in Royal Gardens as $25,600,000.  It also reported a corresponding charitable deduction of $19,200,000 for the gift of its 75% interest in Royal Gardens to the Foundation, and a deduction of $6,400,000 for the gift of its 25% interest to the Church. The Commissioner issued a notice of deficiency determining, among other things, a decrease in the estate’s charitable contribution deduction to $21,405,796. [1]

Analysis

The Commissioner argued that, because both the Foundation and the Church received only a partial interest in Royal Gardens, lack of control and lack of marketability discounts should apply to those gifts.  The value of the deduction, the Commissioner argued, should reflect the value received by the charity.

The estate disagreed, arguing that applying valuation discounts to charitable gifts would undermine the public policy encouraging charitable giving.  Furthermore, the estate argued that, because it held 100% of the interest in Royal Gardens and gave that 100% to charitable organizations, it was entitled to deduct 100% of the Royal Gardens value.

The Commissioner and the estate both cited the Ninth Circuit case of Ahmanson Foundation v. United States[2] as support for their positions.  In Ahmanson, the decedent owned 100 shares of a corporation.  Upon his death, he gave 99 nonvoting shares to a charitable foundation and one voting share to his son.  The Ninth Circuit ruled that the 100 shares were fully includable in the decedent’s estate, but the charitable deduction for the gift of 99 nonvoting shares would be discounted.  The Tax Court summarized the Ahmanson ruling by stating that “when valuing charitable contributions, we do not value what an estate contributed; we value what the charitable organizations received.”

The Warne estate argued that, unlike Ahmanson, 100% of the Royal Gardens value was given to charity, and therefore a valuation discount should not apply.  The Tax Court disagreed, ruling that it does not matter who receives the majority interest, “it is the value of the property received by the donee that determines the amount of the deduction available to the donor.”  The Tax Court went on to uphold the charitable valuation discounts stipulated to by the parties.

Takeaway

This case illustrates the fact that, even when 100% of a decedent’s interest in property passes to charitable beneficiaries, valuation discounts may still apply, resulting in the estate paying some estate tax on such property.  Therefore, it is important to think about the structure of the charitable gifts during the planning stage, and to note any split when calculating the actual value of the gift after the decedent’s death.  If the decedent had left the interest in the LLC to only one of the charities, it would have received a full charitable deduction, resulting in no estate tax payable with respect to such property.

[1] The Commissioner disputed the appraised value, the reported valuation discounts, or both, for each of the five LLCs owned by the Warne family.  Where these values were disputed, the Tax Court provided a detailed analysis of both the estate’s and the Commissioner’s expert evaluations, and the ultimate determination as to the value and discount of each property in dispute.  The valuation of the four LLCs for which no charitable deduction was claimed is not part of this discussion.

[2] Ahmanson Found. v. United States, 674 F.2d 761 (9th Cir. 1981).

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