Tax disputes can drag on for years as illustrated in a recent case. At issue was the proper value of an inherited interest in a family business.
A woman received a 41 percent interest in her families Oregon timber business that held almost 48,000 acres of timberland and employed 12 to 15 people in its forestry operations. An estate tax return filed more than six years ago reported the value at approximately $12.6 million.
The IRS found that the claimed value of the limited partnership interest was incorrect and should have been $35.7 million. The agency issued a notice of deficiency and an accuracy-related penalty of $2.5 million.
Tax court litigation
The disagreement headed to court. Prior to trial, revised estimates were still approximately $20 million apart. What created the differing figures? There are various methods to value a business. The two methods used in the case were:
- Discounted cash flow (DCF) – takes into account the present value assuming that operations continue
- Asset method – value of partnership is all assets were sold
The parties agreed to the value of the timberland, which was the main asset of the business.
The court found a 25 percent chance that the timberland would be sold and the partnership liquidated and used the asset method and the DCF method. It applied a discount for delays in selling the land to come to a value of about $27.5 million.
An appeal and reduction in the valuation
The estate appealed the tax court holding. The Ninth Circuit found the Tax Court erred in using the asset method at all. The appeals court held that the for any outside buyer it would have been difficult to become a limited partner in the first place and almost impossible to convince the general partners to dissolve the partnership.
Using solely the DCF method and a risk premium ultimately lowered the valuation to about $13.9 million (less than half the original IRS assigned valuation). This decision issued in June.
Valuating complex inherited assets can be tricky. If you have inherited a portion of a family business from a loved one, seek the guidance of a tax attorney to limit the risk of a protracted legal battle over the amount of taxes that need to be paid.