Fifth Circuit Decision Affirms Importance of Documenting Valuation Discounts

In the recent decision Estate of James A. Elkins, Jr. v. Comm’r, the Fifth Circuit Court of Appeals ruled that artwork owned by an estate was entitled to a significant 45% valuation discount, resulting in an over $14 million estate tax refund.  At the time of his death, James Elkins, the decedent, owned a 50% or 73% interest in 63 pieces of art.  His children owned the other percentage interests.  Elkins and his children entered into agreements restricting the sale of any interest in the artwork without the consent of all other owners.  After Elkins died, the estate tax return applied a 45% valuation discount to Elkins’s percentage interests in the artwork, because as a holder of a fractional interest, Elkins lacked the ability to control the artwork or sell it freely.  The IRS disagreed with the discount, and took the position that no discount applied.

litigationWhen the case reached the Tax Court, the estate presented expert and family testimony to support its 45% discount.  The IRS continued to argue that no discount was permissible.  The Tax Court rejected both the estate’s and IRS’s positions, and instead held that a 10% nominal discount applied.  Neither the estate nor the IRS presented any evidence supporting a 10% discount.

The Fifth Circuit Court of Appeals disagreed with the Tax Court’s approach.  According to the Fifth Circuit, once the Tax Court rejected the IRS’s argument that no discount was permissible, the Tax Court was required to evaluate the evidence presented by the parties to determine the discount percentage.  Only the estate had presented any evidence supporting a discount, and the estate’s evidence (the credibility of which was not at issue) supported a 45% discount.  The Tax Court could only rule based on the evidence before it; the 10% discount was unsubstantiated.  Accordingly, the estate’s 45% discount was upheld.

The Elkins decision shows the importance of documenting a valuation discount on an estate or gift tax return, preferably with an appraisal provided by a qualified appraiser.  The Elkins estate could support the substantial discount with expert testimony, including the testimony of appraisers, and prevailed because the IRS failed to present evidence of a lower discount.  Obtaining an appraisal and securing the services of expert witnesses appears to have been well worth the expense for the Elkins estate.