Asset freezing rules.
One of two "standard" methods for freezing
the value of a business is the buy-sell agreement. The purchase of a business
at an option price granted in the founder's will should, theoretically,
establish its value. But when the buyers are, say, the founder's children, the
value for estate tax purposes may be questioned.
For many years the process operated under regulations
which, in effect, taxed the business at its fair market value, regardless of
the price set in a buy-sell agreement. Those regulations were validated by an
addition to the Code in 1990. That addition deals with the entire gamut of
freezing values for estate tax purposes, not just businesses. In general, it
employs the technique of setting a value of zero on any rights in property
retained by the transferor of an interest. A gift of stock, for example, with
the transferor retaining a life estate in the securities calls for a gift tax
based on the full value of the stock. The value of the retained interest is
zero.
The significant portion of these
"antifreeze" sections for buy-sell purposes is one providing that
property is valued without regard to any option, agreement to acquire at less
than its fair market value, or any restriction on the right to use the
property. In short, on the death of a holder of stock, the stock is valued at
its fair market value. Options, restrictions, contracts to buy at a stated
price all are ignored if they lead to a value for the stock other than its fair
market value without taking those things into account.
An exception is provided to this foundation rule, but
it is an exception that leads back to the same result. This exception provides
that the above rule does not apply to any option, agreement, right, or
restriction that meets three requirements:
1. It is a bona fide business arrangement.
2. It is not a device to transfer the stock to family
members for less than its full monetary value.
3. Its terms are "comparable to similar
arrangements entered into by persons in an arms' length transaction."Â
Each of these three requirements must be met.
For unrelated parties, a 50 percent rule is in
effect. If more than 50 percent (by value) of stock is owned by nonfamily
members, rights and restrictions on the stock will not be disregarded. For this
purpose, members of a transferor's family include any individual who is a
"natural object of the transferor's bounty."
Before the Code was amended to include the provisions
discussed above, regulations on the subject required four things before the
value in a buy-sell agreement became binding for estate tax purposes:
1. The shares must be subject to an obligation or
option to purchase that is binding on the estate. The buyer is not obligated to
purchase the shares, but the estate must be bound to sell them. (The usual
buy-sell agreement, though, is binding on both sides since the estate normally
needs the funds from the transaction.)
2. The value, or valuation method, must fix the
purchase price with certainty.
3. The shares cannot have been subject to lifetime
transfers that would defeat the right to purchase. At a minimum, a right of
first refusal must be part of the agreement. It is the position of the IRS that
the first refusal price cannot exceed the option price on death in order for
the option price to be valid.
4. The agreement to purchase must be a bona fide
business agreement, not a device to transfer shares at a low value to the
objects of the decedent's bounty.
Though these regulations were adopted before the new
Code provisions, their import is likely to be significant in future
adjudications of buy-sell valuations