Valuation of indirect ownership of a capital or profits interest in a partnership through a trust.
Last Monday’s post discussed a recent CCA and its conclusion regarding grantor trusts as disregarded entities. This post reviews the CCA’s analysis of non-grantor trusts and their interaction with IRC §267 and IRC §707(b)(1)(A).
Both code sections (mentioned above) aim to limit loss recognition when a transaction occurs between related parties. While IRC §267 applies more broadly, IRC §707(b)(1)(A) (which is part of Subchapter K) applies to transactions between a partnership and its partners.
The memorandum’s analysis of the application of IRC §707(b)(1)(A) requires the application of IRC §267(c). Part (c) of IRC §267 details the rules for constructive ownership for stock (or other interests) owned through corporations, partnership, estates or trusts. However, there are no rules provided as to **how** an estate or trusts’ beneficiary’s interest should be valued. Are only current income beneficiaries considered? Or should remaindermen be factored in?
The analysis focused on a review of Hickman v. Commissioner (T.C. Memo. 1972-208). This this case, the IRS argued that the beneficiaries (a husband and wife) were more than 50% owners of stock because they were the sole income beneficiaries of the trust. The taxpayers argued that their ownership should be determined actuarially, which would have resulted in ownership of less than 50%.
The taxpayers relied on Rev. Rul. 62-155 which says that “shares held by a trust are considered to be owned by its present or future beneficiaries in proportion to their actuarial interests.” While this Revenue Ruling was specifically referring to different parts of IRC (the Code of 1954 at that!), they thought the valuation should be applied to them.
The court found that the Rev. Rul. 62-155 argument was not applicable to the valuation for §267(c) purposes. The IRS prevailed with its position that the income beneficiaries were the owners though the trust of the stock.
[In addition, the court squashed another taxpayer argument that the fair market valuation rules of Treas. Reg. §20.2031-1 should be used to value the present and remainder interests.]
The current memorandum summarized its analysis of §267 and §707(b)(1)(A) here:
“We believe that to apply the §267(c) rules in the instant case, it is necessary first to ascertain the total capital or profits interest in Taxpayer owned by each selling trust. Second, it is necessary to determine the specific beneficiaries of each selling trust that should be treated as proportionately owning a capital or profits interest in Taxpayer. Third, it is necessary to determine each beneficiary’s proper ownership portion of the capital or profits interest in Taxpayer that is owned by the respective selling trust in comparison to all other beneficiaries’ proper ownership interest or total capital or profits interest. The factors considered to determine the beneficiaries that should be taken into account as owning a capital or profits interest and to compute a specific beneficiary’s proper ownership portion of the capital or profits interest of Taxpayer owned by a particular trust should be in accordance with the intendment of §707(b). Once a beneficiary’s proportional capital or profits interest in Taxpayer is established under §267(c)(1), the constructive ownership rules of §267(c) must be further applied to attribute ownership to other specified persons (e.g., family members) for purposes of determining a person’s direct and indirect ownership of the capital or profits interest of Taxpayer.”
Source: CCA 201343021
Source: Hickman v. Commissioner, T.C. Memo. 1972-208