What exactly does Revenue Ruling 93-12 hold?
That shares held by other family members are not added to the gifted block. Revenue Ruling 93-12, 1993-1 C.B. 202, poses the question in its own words — “If a donor transfers shares in a corporation to each of the donor’s children, is the factor of corporate control in the family to be considered in valuing each transferred interest, for purposes of section 2512 of the Internal Revenue Code?” — and answers it no. Its facts are the ordinary family-company fact pattern: “P owned all of the single outstanding class of stock of X corporation. P transferred all of P’s shares by making simultaneous gifts of 20 percent of the shares to each of P’s five children, A, B, C, D, and E.” The holding is that “the factor of corporate control in the family is not considered in valuing each transferred interest for purposes of section 2512 of the Code,” and that “a minority discount will not be disallowed solely because a transferred interest, when aggregated with interests held by family members, would be a part of a controlling interest. This would be the case whether the donor held 100 percent or some lesser percentage of the stock immediately before the gift.”
The machinery underneath that result is the gift tax valuation rule itself. Internal Revenue Code §2512(a) provides that “[i]f the gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift,” and Treasury Regulation §25.2512-1 supplies the standard: “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.” The same regulation fixes the unit being valued: “The value is generally to be determined by ascertaining as a basis the fair market value at the time of the gift of each unit of the property. For example, in the case of shares of stocks or bonds, such unit of property is generally a share or a bond.” What is valued is the property that moved, at the moment it moved. Revenue Ruling 93-12 draws the consequence in one line: the minority interests transferred “should be valued for gift tax purposes without regard to the family relationship of the parties.”
“Minority discount” is loose shorthand, and it is worth unpacking before it is relied on, because Revenue Ruling 93-12 removes an objection rather than supplying a discount. A discount for lack of control and a discount for lack of marketability are two different adjustments on the level-of-value axis, answering two different questions — what the block cannot direct, and how hard it is to convert into cash — and each has to be developed and supported on its own facts. Treasury Regulation §25.2512-2(f), which governs where actual sale prices and bona fide bid and asked prices are lacking, names the company’s “net worth, prospective earning power and dividend-paying capacity, and other relevant factors,” and then lists among those other relevant factors “the degree of control of the business represented by the block of stock to be valued,” alongside goodwill, the economic outlook in the particular industry, the company’s position in the industry and its management, and the values of listed securities in the same or similar lines of business. Revenue Ruling 93-12 says family holdings are not added to the block for that purpose. It does not say what the block is worth. See Discounts and premiums for how the standard of value, the premise and the level of value sit on three separate axes.
Does it matter that the family still controls the company after the gift?
Not on its own, and that is the specific proposition Revenue Ruling 93-12 was issued to abandon. The Internal Revenue Service had held the opposite position since 1981. As Revenue Ruling 93-12 describes it, Rev. Rul. 81-253, 1981-1 C.B. 187, held that “ordinarily, no minority shareholder discount is allowed with respect to transfers of shares of stock between family members if, based upon a composite of the family members’ interests at the time of the transfer, control (either majority voting control or de facto control through family relationships) of the corporation exists in the family unit,” and stated that the Service would not follow the Fifth Circuit’s decision in Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981). Revenue Ruling 93-12 revoked Rev. Rul. 81-253 outright.
What changed was that the Internal Revenue Service had lost the argument in four decisions, and Revenue Ruling 93-12 says so on its face. In Estate of Bright the decedent’s undivided community property interest in shares, together with the corresponding undivided community property interest of the surviving spouse, constituted a control block of 55 percent of the corporation’s shares; because the community-held shares were subject to a right of partition, the court held that the decedent’s own interest was equivalent to 27.5 percent of the outstanding shares and should therefore be valued as a minority interest, even though the shares were to be held by the surviving spouse as trustee of a testamentary trust. The ruling adds a see-also citation to Propstra v. United States, 680 F.2d 1248 (9th Cir. 1982), and reports that Estate of Andrews v. Commissioner, 79 T.C. 938 (1982), and Estate of Lee v. Commissioner, 69 T.C. 860 (1978), held that corporation shares owned by other family members cannot be attributed to an individual family member for determining whether that member’s shares should be valued as the controlling interest of the corporation. It then commits the Service: “For estate and gift tax valuation purposes, the Service will follow Bright, Propstra, Andrews, and Lee in not assuming that all voting power held by family members may be aggregated for purposes of determining whether the transferred shares should be valued as part of a controlling interest.” Estate as well as gift — the non-aggregation position is not confined to lifetime transfers. Revenue Ruling 93-12 also substituted acquiescence for the Service’s earlier nonacquiescence in issue one of Estate of Lee.
Two limits on Revenue Ruling 93-12 are worth reading before it is leaned on. First, its analytical paragraph is framed narrowly: the Service concluded that “in the case of a corporation with a single class of stock,” and notwithstanding the family relationship of donor, donee and other shareholders, the shares of other family members will not be aggregated with the transferred shares; the holding paragraph then states the rule without repeating that qualifier. Chapter 14 of the Internal Revenue Code supplies its own special valuation rules at §§2701 through 2704, and those have to be run in their own right whatever the ruling says about aggregation. Second, Revenue Ruling 93-12 is the Internal Revenue Service’s own published position rather than a judicial holding. What makes it durable is where it came from: it was issued in retreat from four decisions that had gone against the Service, and it revoked the ruling that had told examiners to press the point.
Why is a minority discount allowed on a gift when it is barred in a statutory appraisal?
Because the two proceedings run under different standards of value, and in each of them the standard is supplied by law rather than chosen by the appraiser. A gift of shares is valued at fair market value, the hypothetical willing buyer and willing seller construct of Treasury Regulation §25.2512-1 and, for estates, §20.2031-1(b). A statutory appraisal or dissenters’ rights proceeding is valued at fair value, a creature of the forum’s corporation statute and its case law. The same shares, held by the same family, on the same date, carry opposite instructions on the same adjustment depending on which of those two proceedings the reader is standing in.
Where a state has enacted the appraisal definition drawn from the Model Business Corporation Act, the bar sits on the face of the statute rather than in the case law. Virginia is a verified example: Va. Code §13.1-729 defines fair value in a single three-part sentence that fixes the date, the methodology instruction and the discount rule together — value determined “[i]mmediately before the effectiveness of the corporate action to which the shareholder objects,” “[u]sing customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal,” and “[w]ithout discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles of incorporation pursuant to subdivision A 5 of §13.1-730.” Delaware reaches a comparable place through case law. In Cavalier Oil Corp. v. Harnett, 564 A.2d 1137 (Del. 1989) — an appraisal following a short-form merger of a closely held Delaware corporation under 8 Del. C. §253 — the Supreme Court of Delaware held that the Court of Chancery’s task was to value what has been taken from the shareholder, “viz. his proportionate interest in a going concern” (quoting Tri-Continental Corp. v. Battye, 74 A.2d 71, 72 (1950)); that “[t]he dissenting shareholder’s proportionate interest is determined only after the company as an entity has been valued”; and that in that determination “the Court of Chancery is not required to apply further weighting factors at the shareholder level, such as discounts to minority shares for asserted lack of marketability.” The company argued that the dissenter’s 1.5 percent interest was itself a relevant factor. The court answered that “[t]he application of a discount to a minority shareholder is contrary to the requirement that the company be viewed as a ‘going concern.’”
Note carefully what those authorities do and do not say, because two claims in wide circulation do not survive them. They bar named shareholder-level adjustments; they do not establish that “fair value means no discounts,” which is a category error in any event — a standard of value is a definition, a discount is a level-of-value adjustment, and whether a particular standard permits a particular adjustment is a third question, answered by the forum’s law rather than by the definition. Nor does the absence of those adjustments make fair value the larger number as a rule. In Delaware merger appraisal the exclusion runs in the opposite direction: 8 Del. C. §262(h) directs that fair value be determined “exclusive of any element of value arising from the accomplishment or expectation of the merger,” which can put the appraised figure below the price the buyer actually paid. See Fair value and fair market value for who imposes each definition, and Appraisal and dissenters’ rights for how the statutory bar operates inside a buyout.
Which instruction applies is a question of law, settled before an appraiser opens a spreadsheet, and the Supreme Court of Colorado said so in terms. In Pueblo Bancorporation v. Lindoe, Inc., 63 P.3d 353 (Colo. 2003), the court held that “the meaning of ‘fair value’ is a question of law, not an issue of fact to be opined on by appraisers and decided by the trial court on a case-by-case basis.” The transfer tax side is fixed the same way — by regulation and by the Internal Revenue Service’s published position — rather than by valuation judgment. What is left to the expert sits on the other layer entirely, and it is reviewed quite differently: in the same case, the Colorado Court of Appeals had stated the companion rule that “[a] fair value determination is a factual one, and therefore, the trial court’s valuation will not be disturbed unless clearly erroneous.” Pueblo Bancorporation v. Lindoe, Inc., 37 P.3d 492 (Colo. App. 2001), aff’d, 63 P.3d 353 (Colo. 2003). Two levers, two standards of review, and the first is not the appraiser’s to pull.
What can the Internal Revenue Service still challenge if family control is not the objection?
The size of the discount, the evidence developed to support it, and whether the restrictions relied on are ones the Internal Revenue Code instructs the valuer to ignore. Revenue Ruling 93-12 disposes of a single argument — that family holdings should be aggregated with the transferred block — and leaves every other line of attack in place. Two Code sections do the ignoring, and both arrived in the same statute: Internal Revenue Code §§2703 and 2704 were added by Pub. L. 101-508, §11602(a), on 5 November 1990.
Internal Revenue Code §2703(a) directs that the value of property be determined without regard to “any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right)” or “any restriction on the right to sell or use such property.” Section 2703(b) restores the arrangement only where it meets each of three requirements: “[i]t is a bona fide business arrangement”; “[i]t is not a device to transfer such property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth”; and “[i]ts terms are comparable to similar arrangements entered into by persons in an arms’ length transaction.” Internal Revenue Code §2704(b) disregards an “applicable restriction” where an interest is transferred to a member of the transferor’s family and the transferor and family hold control immediately before the transfer — a restriction that “effectively limits the ability of the corporation or partnership to liquidate” and either lapses after the transfer or can be removed by the transferor or the family — while excepting commercially reasonable restrictions arising from financing with an unrelated person and restrictions “imposed, or required to be imposed, by any Federal or State law.” Section 2704(a) is the lapse rule: where a voting or liquidation right lapses and the holder and the holder’s family hold control both before and after, the lapse is treated as a transfer by gift or as includible in the gross estate, measured by the excess of the value of that holder’s interests determined as if the voting and liquidation rights were nonlapsing over their value immediately after the lapse.
A restriction that survives Internal Revenue Code §§2703 and 2704 can still do far less work than the report claims for it, and the point is made squarely in a family-company gift tax case. In Mandelbaum v. Commissioner, T.C. Memo. 1995-255, the taxpayers’ expert leaned heavily on shareholders’ agreements containing a right of first refusal. The court found that reliance “especially troublesome, given the fact that the agreements specify no price or formula (such as book value per share) at which the shares must be offered,” and held that “[i]n most cases, especially where an operating company is concerned, a right of first refusal without a fixed price has little, if any, effect on fair market value,” because such a right “does not limit the buyers to whom a seller could sell his or her stock, or the price for that stock, but merely governs the order in which prospective buyers must stand in line to buy the stock.” Because the right protects the other shareholders, who are given the first opportunity to buy, the court added that “the depressant effect (if any) on the value of privately held stock subject to a right of first refusal is not necessarily substantial.” A restriction that reorders the queue is not a restriction that fixes the price.
Nor can the figure be borrowed from other cases. The Internal Revenue Service’s Discount for Lack of Marketability Job Aid for IRS Valuation Professionals (Engineering/Valuation Program DLOM Team, 25 September 2009), which states on every page that it is “not Official IRS position” and “may not be used or cited as authority for setting any legal position,” dismantles the practice of selecting a discount from the range courts have accepted: “judges are not valuators and are not constrained to the environment in which professional valuators operate,” so the courts “are an excellent source of information when legal precedent is in question but can be a very questionable source when valuation guidance is desired.” Its conclusion is blunter still: “basing one’s results on the results of another assignment whether litigated or not is a failure of proper diligence with regard to the assignment presently at hand.” This Institute publishes no discount percentage, no range and no table of discounts courts have allowed, for the same reason. A concluded discount in a decided case is a litigation outcome on one record, produced by whatever those two parties put in front of that judge.
Did the 2016 proposed section 2704 regulations end discounts on family entity transfers?
No. The proposed regulations under Internal Revenue Code §2704 never took effect and were withdrawn in their entirety, and a good deal of commentary still in circulation describes them as though they had. The Treasury Department and the Internal Revenue Service published the notice of proposed rulemaking (REG-163113-02) in the Federal Register on 4 August 2016 at 81 FR 51413, received numerous written comments and held a public hearing on 1 December 2016. The withdrawal, published at 82 FR 48779 on 20 October 2017, states it plainly: “the notice of proposed rulemaking (REG-163113-02) that was published in the Federal Register on August 4, 2016 (81 FR 51413) is withdrawn.”
The reason the Treasury Department gave is more useful than the fact of withdrawal, because it names the thing valuers were being asked to do and could not. Executive Order 13789, issued 21 April 2017, directed a review of significant tax regulations issued on or after 1 January 2016; Notice 2017-38 included the §2704 proposal in a list of eight regulations identified in the resulting interim report; and the Second Report to the President on Identifying and Reducing Tax Regulatory Burdens, published at 82 FR 48013 on 16 October 2017, recommended complete withdrawal. Its stated ground was that “Treasury and the IRS now believe that the proposed regulations’ approach to the problem of artificial valuation discounts is unworkable,” because “taxpayers, their advisors, the IRS, and the courts would not, as a practical matter, be able to determine the value of an entity interest based on the fanciful assumption of a world where no legal authority exists.” The same report records the commenters’ objection that “the lack of a market for interests in family-owned operating businesses is a reality that … should continue to be taken into account when determining fair market value.”
What the withdrawal did not do is repeal anything. Internal Revenue Code §2704 is untouched and still operates on its own terms: §2704(a) on lapsing voting and liquidation rights, §2704(b) on applicable restrictions, and §2704(b)(4)’s standing authority for the Secretary to provide by regulation that other restrictions be disregarded where a restriction “has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.” The 2016 proposal was Treasury’s attempt to exercise that authority, and it is the attempt that was withdrawn, not the authority. So the working position is the one that has held on both halves of the question: family attribution is not the objection, and the restrictions inside a family entity are tested case by case against Internal Revenue Code §§2703 and 2704 rather than by rule. See Family entities and transfer restrictions.
What happens if the discount claimed on a gift tax return turns out to be too large?
Two consequences run in parallel, and both are statutory rather than reputational: an accuracy-related penalty computed off fixed percentage thresholds, and, where the return did not disclose the discount in the detail the regulations require, a limitations period that never begins to run. Neither depends on bad faith, and the second does not depend on the discount being wrong.
The penalty is Internal Revenue Code §6662. Section 6662(a) adds 20 percent of the portion of the underpayment to which the section applies, and §6662(b)(5) applies it to “[a]ny substantial estate or gift tax valuation understatement.” Section 6662(g)(1) defines that as existing where “the value of any property claimed on any return of tax imposed by subtitle B is 65 percent or less of the amount determined to be the correct amount of such valuation,” and §6662(g)(2) bars the penalty unless the portion of the underpayment attributable to such understatements exceeds $5,000. Section 6662(h)(2)(C) defines a gross valuation misstatement to include the same understatement computed “by substituting ‘40 percent’ for ‘65 percent,’” and §6662(h)(1) then doubles the rate by substituting “40 percent” for “20 percent.” One trap is worth naming because it gets imported constantly: §6662(e)’s more familiar thresholds — 150 percent for a property value or adjusted basis claimed on a chapter 1 return, and 200 percent or 50 percent for a section 482 transfer price — are the income tax rules and have nothing to do with a transfer tax valuation.
The disclosure rule is the one that surprises people, because it turns on the return rather than on the merits of the discount. Internal Revenue Code §6501(a) gives the Internal Revenue Service three years from the filing of the return to assess. Section 6501(c)(9) removes that limit for a gift required to be shown on a gift tax return and not shown, except for “any item which is disclosed in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item,” and Treasury Regulation §301.6501(c)-1(f)(1) provides that where a transfer is not adequately disclosed the gift tax “may be assessed, or a proceeding in court for the collection of the appropriate tax may be begun without assessment, at any time.” What adequate means is enumerated rather than left to judgment. Regulation §301.6501(c)-1(f)(2)(iv) requires “a detailed description of the method used to determine the fair market value of property transferred,” including any financial data used, “any restrictions on the transferred property that were considered in determining the fair market value of the property,” and “a description of any discounts, such as discounts for blockage, minority or fractional interests, and lack of marketability, claimed in valuing the property.” Where the value of an interest in a non-actively-traded entity is properly determined on the net value of the entity’s assets, the return must also state the fair market value of 100 percent of the entity “determined without regard to any discounts in valuing the entity or any assets owned by the entity,” the pro rata portion subject to the transfer, and the fair market value of the transferred interest as reported — and “[i]f 100 percent of the value of the entity is not disclosed, the taxpayer bears the burden of demonstrating that the fair market value of the entity is properly determined by a method other than a method based on the net value of the assets held by the entity.”
Treasury Regulation §301.6501(c)-1(f)(3) supplies an alternative route: submitting an appraisal of the transferred property that meets the listed requirements satisfies §301.6501(c)-1(f)(2)(iv). The appraiser must hold himself or herself out to the public as an appraiser or perform appraisals on a regular basis, must be qualified by background, experience, education and professional membership to appraise the type of property being valued, and must not be the donor or the donee, a member of the family of either as defined in Internal Revenue Code §2032A(e)(2), or any person employed by them. The appraisal must state the date of the transfer, the date the property was appraised and the purpose of the appraisal, describe the property and the appraisal process employed, and describe “the assumptions, hypothetical conditions, and any limiting conditions and restrictions on the transferred property that affect the analyses, opinions, and conclusions.” A discount that is well supported and badly disclosed is still a discount taken on an open return. Nothing on this page says what any interest is worth, what discount any particular gift will support, or whether any return was adequately disclosed: this Institute maps the frameworks and the questions, counsel chooses, and the appraiser opines. See Estate and gift valuation.