Valuation of Restricted Management Account Gifts for Gift Tax
Purposes
By William P. Streng, Vinson & Elkins Professor of
Law
University of Houston Law Center, Houston, TX
Determining the proper valuation for a transferred asset in the
gift or estate tax context is a recurring “cat and mouse”
game between the taxpayer and the IRS. Since valuation often involves
a factual dispute this is fertile territory for the IRS to extract
some tax revenue, assuming it can appropriately assert the
applicability of some substantive transfer tax provision to enable
transfer tax nexus.
Some years ago, in Rev. Rul. 93-12, 1993-1 C.B. 202 (enabling
minority interest valuation discounts for the transfers of divided
interests in corporate shares) the IRS opened the door for
facilitating positions by taxpayers to assert eligibility for
valuation discounts for transferred property interests. In the
intervening period since that published ruling, taxpayers have been
able to exploit opportunities for significant discounts for the
transfers of family limited partnership (FLP) interests. This has
occurred even when much of the property held inside the FLP consists
significantly of liquid assets. Legislative proposals aimed at
limiting the utilization of family limited partnerships to achieve
significant valuation discounts for transfer tax purposes have been
without success. The net result is often a significant reduction of
the effective federal tax rate on gratuitous transfers.
At the edges of this issue the IRS periodically attempts to limit
efforts by taxpayers to create a facade that transfer limitations do
exist and, therefore, that discounts should be available. An example
of a 2008 IRS position in this context is Rev. Rul. 2008-35, 2008-29
I.R.B. 116. As identified in this ruling a depositor entered into an
agreement with a bank to deposit marketable securities and cash into a
restricted management account (designated as an “RMA”).
The (non-tax motivated) purpose of the RMA was to enhance the
investment performance of the portfolio by allowing the bank (and any
appointed investment advisor) to maximize the portfolio's long term
performance without the risk of the withdrawal of the assets from the
RMA by the owner. The owner was permitted to transfer all or portions
of the RMA account itself to others by gift, but the transferred
portion would remain subject to the terms of the RMA, as originally
agreed by the transferor.
The IRS concluded that, for gift and estate tax purposes, the
interposition of the binding RMA agreement to facilitate an orderly
management of the transferor's assets does not function to reduce the
fair market value of the assets subject to the RMA agreement if
transferred by gift. Similarly, if this property is held at death
subject to an RMA agreement, the fair market value of the property is
included in the owner's gross estate at its fair market value and
without any discount by reason of being subjected to the RMA
agreement. In Rev. Rul. 2008-35, the IRS asserts that at all times the
transferor holds a property interest in the assets in the RMA and that
the Bank has no interest in any of these assets.
The IRS noted that the RMA agreement is a management contract
between the owner of the property and the person agreeing to serve as
the property manager. Any restrictions imposed by the RMA agreement
relate primarily to the performance of the management contract (e.g.,
establishing and ensuring a long-term investment horizon to be pursued
by the investment manager), rather than to substantive restrictions on
the underlying assets held in the RMA. The IRS indicated that any
restrictions on the ability to withdraw assets, terminate the
agreement, or transfer interests in the RMA do not impact the price at
which those assets would change hands between a willing buyer and a
willing seller and, therefore, do not impact the value of those assets
in the RMA. The IRS indicated that this arrangement is similar to
those situations where taxpayers receive no valuation discount for
assets held in an IRA or retirement plan account (and where income tax
will accrue upon distribution). The IRS explicitly noted that the
estate tax transfer provision, §2036, will apply to cause the
retained interest in the assets held in the RMA to be included in the
owner's gross estate for federal estate tax purposes.
The RMA arrangement can be differentiated from the FLP situation
where the owners hold partnership interests and do not hold undivided
interests in the assets held by the partnership. Without the
cooperation of the majority of the other partners, the partner in the
FLP can only obtain benefits from the partnership interest through a
“charging order” or similar arrangement, as permitted
under local partnership law, to facilitate the partner's realization
of the benefits of the partner's interest. This important state law
difference enables differentiation in the FLP context from the IRS's
position in Rev. Rul. 2008-35. However, taxpayers should anticipate
that, at the edges, the Service might use its position in other
situations similar to the RMA structure to assert that certain local
law arrangements are without impact for diluting fair market value for
measuring tax exposure in gratuitous property transfers. Although a
partnership is not necessarily required to achieve this value
reduction, taxpayers must arrange alternative bifurcated property
ownership situations so that the local law property restrictions can
be treated as having binding and significant impact for transfer tax
valuation purposes.
For more information, in the Tax Management Portfolios, see
Hood, 830 T.M., Valuation: General and Real Estate, and in Tax
Practice Series, see ¶6290, Valuation--Generally.
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