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Tax Court upholds value of bank stock established in family agreement

Subsequent to entering into the FSA, Rod entered into an agreement with the bank in 1997 whereby the bank agreed to purchase its stock that Rod inherited from Pearl for $217.50 per share plus a 4% per year increase in the price after 1998. After Pearl’s death, Rod sold the stock to the bank for $1.5 million pursuant to this agreement.

The IRS contended that the FSA did not fix the price of the bank stock in Pearl’s estate because it failed to satisfy certain Internal Revenue Code requirements which would make it legally binding on the IRS. However, the Tax Court saw things differently and sided with the estate.

First, the court found that the FSA set a fixed and determinable price for the shares and was legally binding on Pearl both during her life and at death. Second, the court found the FSA to be a bona fide business arrangement in that Pearl was simply trying to mitigate the risks of holding a minority interest in a closely-held stock. It did not matter that the bank stock was merely

Pearl Amlie died in 1998 at age 96. One of the assets in her estate consisted of a minority position in the stock of First American Bank Group, Ltd., a closely-held bank that did not pay dividends. At issue was the price at which this bank stock should be included in Pearl’s estate for Federal estate tax purposes. Pearl’s estate tax return listed the value of the stock at approximately $1 million. On audit, the IRS revalued the stock at approximately $1.5 million.

The estate based its value on a 1995 family settlement agreement (FSA) entered into by Pearl and all of her children. The FSA provided that Pearl could not sell any of her bank stock without first obtaining the consent of her son, Rod, and his family. The FSA also provided that Rod’s shareof the bank stock valued at $118 per share. Any excess shares of this bank stock remaining in Pearl’s estate were subject to reciprocal put/call options at the $118 price between Pearl’s estate and Rod and his family.

Subsequent to entering into the FSA, Rod entered into an agreement with the bank in 1997 whereby the bank agreed to purchase its stock that Rod inherited from Pearl for $217.50 per share plus a 4% per year increase in the price after 1998. After Pearl’s death, Rod sold the stock to the bank for $1.5 million pursuant to this agreement.

The IRS contended that the FSA did not fix the price of the bank stock in Pearl’s estate because it failed to satisfy certain Internal Revenue Code requirements which would make it legally binding on the IRS. However, the Tax Court saw things differently and sided with the estate.

First, the court found that the FSA set a fixed and determinable price for the shares and was legally binding on Pearl both during her life and at death. Second, the court found the FSA to be a bona fide business arrangement in that Pearl was simply trying to mitigate the risks of holding a minority interest in a closely-held stock. It did not matter that the bank stock was merely an investment asset to Pearl, rather than an actively managed business interest.

Next, the court found that the FSA was not merely a testamentary device to try to transfer the bank stock from Pearl’s estate to Rod. Rather, the court stated that Pearl received significant consideration for entering into the FSA because it fixed the price for a minority interest in a closely-held stock that otherwise was shrouded in much uncertainty and substantial litigation hazards. Also, the court noted that since Pearl’s other children were parties to the agreement, the FSA was an arm’s length decision. If the FSA undervalued Pearl’s stock, that was a chance that Rod’s siblings apparently were willing to take.

Finally, the court found that the FSA’s $118 per share price was supported by comparable arrangements entered into at arm’s length and was also supported by prior negotiations between Pearl and the bank to fix a price for her stock which occurred before the FSA was executed.

  • Partner

    John is Chair of the firm's Estate Planning Department. He also leads the firm's Senior Partner Committee, and is a member of the firm's Finance Committee. John, a former Certified Public Accountant, began his career in the tax ...

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