Trusts and Estates

Ca. Trs. & Estates Quarterly Volume 8, Issue 2, Summer 2002


by Owen G. Fiore, Esq.*

Transfer tax valuation under the hypothetical party rule1 has been a litigation focus of taxpayers and the IRS for decades, one Tax Court Judge recently having referred to this phenomenon as the "valuation game."2 An earlier article in the California Trusts and Estates Quarterly by the author focused on the "valuation spectrum"3 There the discussion emphasized the tax practice impact of an ongoing IRS national compliance program attacking use of pass-through entities (FLPs, LLCs and S corporations) that were used at least in part to create valuation adjustments or "discounts" for Federal transfer tax purposes.4

However, in this article, another current issue affecting estate planning and transfer tax valuation is presented, taking into account the 1999 Tax Court decision in Mellinger v. Commissioner5 and the recent 2002 decision of the Tax Court in Fontana v. Commissioner.6 These decisions, both involving California estates, together provide tax and estate planners with valuable lessons on the use of trusts to develop an effective valuation adjustment strategy.7 The downside of failing to consider these reviewed decisions of the Tax Court in our forward planning efforts with clients clearly is exposure to IRS attack in some cases and also to malpractice claims. Litigation results reviewed here illustrate how the courts often raise the bar for standards of tax practice.8


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