A lot of my focus with tax and legacy planning is done to ensure that the IRS does not take more of your or your loved ones’ estate than is required by law. Under most IRS tax scenarios, especially the wealth transfer taxes (e.g., the gift tax, the estate tax, and the generation skipping transfer tax), the IRS will base its taxes due on the value you have transferred to the next generation. A majority of the planning done for larger estates will look at ways to lower the determined value, so I want to take this opportunity to help my readers learn how the IRS looks at the value transferred.

First, under Tax Court cases, the standard that the IRS must use for a transferred asset must be “what a willing buyer would pay a willing seller, with both fully informed of all facts related to the transfer.” This is commonly termed as the “fair market value” of the asset. For commonly traded assets (think of public stock, feeder cattle, or other readily marketable commodities), the fair market value can be determined by looking to the markets for the day of the transfer and the value assigned based on the trades for that day. But, the IRS has a hard time proving value on assets where there are no public markets. This brings up one of the most commonly used practices in legacy planning, “discounting”.

Under the court interpretations of discounting, the underlying assets do not fully account for the value of the transferred assets, if there are restrictions placed on the transferred assets. So, if you transfer a minority interest in an asset, the true fair market value is actually less than the fraction of the asset actually transferred. The easiest way to show this is by a simple example, so here goes.
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Example: Assume you own 100 acres of land near Altus. We will further assume that this land would sell for about $2,000 per acre based on comparable sales in the area. If you were to transfer this to your (assumed) two children outright, you will have completed a gift of $200,000 and may have to pay gift taxes. However, if you gave your children remainder interests, depending upon your age and health, you would only have transferred about $100,000 in value and would cut your taxes owed in more than half. The same principle would apply with split interests (like adding them as joint tenants) and with placing the land in an LLC and giving them minority interests in the LLC.

You can see that these scenarios can get complicated pretty fast, so if you have a large estate (what the IRS would consider more than $1,000,000) you should contact a qualified estate and tax planning attorney to look at scenarios that will benefit you and your children rather than the tax man. I would like to meet with you and your family to discuss these and other estate planning options for the citizens of Altus and southwestern Oklahoma.