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Business Appraisals and Forensic Economics


The case of Estate of H.A. True, Jr. et al v. Commissioner, T.C. Memo 2001-167 (July 6, 2001) has examined the issues involved with the role of a buy-sell (buyback) agreement in corporate and partnership redemptions among family members. In particular, the following items were considered: a) Does a book value provision control for estate and gift tax purposes (in 1993 and 1994); b) if it does not, what role do the other provisions of these agreements have on determining value; c) if there is a provision for delay in payment, how should it be treated; and d) what would determine liability for underpayment penalties.

The Court went to great lengths to layout the analysis of when a buyback provision has a business purpose or is testamentary (immaterial of whether a corporation or partnership is involved as both were at issue here). Furthermore, these agreements were in existence for a long time, were adjudicated in U.S. District Court as controlling in 1971 and 1973, and were used to effect an actual redemption in 1984.

While this is a very lengthy opinion (336 pages!), in summary the following was found:

1. If an agreement is found to be testamentary (with a low threshold required), any provision providing for redemption at less than fair market value will not control for estate or gift tax purposes and will be ignored.

2. It has been argued the existence of the buyback agreement would increase the lack of marketability by virtue of its existence (even ignoring the establishment of the price). The Court found that if an agreement is found to be testamentary, its existence will be ignored in determining discounts such as lack of marketability and/or lack of control.

3. A provision which allows payment at some time in the future can be considered a below market loan with the imputed interest considered a gift.

4. Because the estate had not used a qualified appraiser (relying only on the buy-sell agreement), they were liable for underpayment penalties.

5. The IRS asserted the "swing vote" concept (where the block at issue could combine with another family member to control) repeatedly. In all cases, the Court ignored the "swing vote" concept.

While this is a "Memo" case, several lessons can be learned from it:

a. When setting up, implementing, or reporting values based on a buy-sell provision either for a corporation or partnership, the tests provided here can be used as a guide as to whether it is likely to be found to be a business purpose or testamentary agreement.

b. Provisions for a buyback at other than Fair Market Value involving family members are highly vulnerable.

c. Values determined by a buyback mechanism should be checked with a qualified appraisal.