Portion of Special-Use Valuation Regulations Held Invalid
Finfrock, 109 AFTR 2d 2012-1439, 2012-1 USTC ¶60641 (DC Ill., 2012).
In Finfrock, 1 the U.S. District Court for the Central District of Illinois held a portion of the regulations under Section 2032A invalid because the court found that the regulation imposed additional requirements not supported by the statute.
At the time of her death, the decedent owned 61.05% of the issued and outstanding stock in the farm corporation Finfrock Farms, Inc. At the time of decedent's death, and for at least eight years prior to her death, Finfrock Farms owned four parcels of real property (the “Property”). For the entire eight years preceding the decedent's death, her son James Finfrock actively farmed the Property owned by Finfrock Farms.
The decedent's estate tax return reported the adjusted value of her gross estate as $2,608,848. The decedent's estate tax return also reported the adjusted value of the Property as $1,775,000, representing approximately 68% of the adjusted value of the gross estate. The estate made an election to specially value only one of the four parcels of the Property. The special-use valuation of the fourth parcel was $227,233. The adjusted value of the fourth parcel was $402,930, which represented approximately 15% of the adjusted value of the gross estate. The estate elected to specially value only the fourth parcel because the decedent's son wished to continue operating only this parcel as a farm, whereas the other three parcels were sold to unrelated third parties shortly after the decedent's death.
On audit, the IRS determined that the estate's election to value only the fourth parcel did not meet the requirements of Reg. 20.2032A-8. Under the Regulation, not only must the adjusted value of all of the estate's qualifying real property exceed 25% of the adjusted value of the gross estate, but the value of the real property for which the executor makes the election must also exceed such 25% threshold. The IRS's position was that because the estate made the election with respect to only parcel four, the adjusted value of which was only 15% of the adjusted value of the gross estate, the estate did not meet this threshold.
Accordingly, the IRS increased the reported value of the fourth parcel from its special-use value of $227,233 to its agreed market value of $402,930 and assessed an additional tax on account of this increase. The estate paid the additional tax and filed a claim for refund. The IRS denied the claim for refund and the estate filed suit in the district court seeking a refund of the additional tax paid.
Section 2032A, which was enacted as part of the Tax Reform Act of 1976, provides that if certain requirements are satisfied, an estate may elect to value real property used for farming or in a trade or business on the basis of the property's use at the time of the decedent's death, rather than based on its highest and best use. One of those requirements is that at least 25% of the adjusted value of the gross estate must consist of qualifying real property. However, Reg. 20.2032A-8 provides that while an estate need not elect special-use valuation with respect to all of the qualifying real property, the property actually elected for special-use valuation must be at least 25% of the adjusted value of the gross estate. The IRS argued that the Regulation was valid and, because the property elected for special-use valuation constituted only 15% of the adjusted value of the gross estate, the estate may not elect special-use valuation. The estate argued that the Regulation was invalid and in conflict with the statute.
The parties agreed that the test articulated by the U.S. Supreme Court in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 2 is the appropriate test to apply when reviewing the Regulation. Under the tests set forth in Chevron, when reviewing an agency's interpretation of a statute, a court must first determine whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, both the court and the agency must give effect to the unambiguously expressed intent of Congress. Therefore, if the plain meaning of a statute either supports or opposes the regulation, then a court need not inquire any further and must either strike or validate the regulation, as the case may be. On the other hand, if the statute is silent or ambiguous with respect to the specific issue, the question for a court is whether the agency's interpretation is based on a permissible construction of the statute. The legislative history and other appropriate factors are generally considered only during step two of the Chevron test.
The estate argued that the statute is clear and unambiguous that the 25% threshold applies only to qualify an estate for the special election but does not require that the executor elect to apply the special-use valuation to property that constitutes 25% or more of the adjusted gross estate. The IRS argued that Section 2032A is silent as to how much of the qualified real property included in the decedent's gross estate must be subject to the special-use valuation election and that, therefore, the IRS clarified this ambiguity by promulgating Reg. 20.2032A-8.
The court observed that under the plain language of the statute, to meet the definition of qualified real property, 25% or more of the adjusted value of the gross estate must consist of real property that both:
- Was acquired from or passed from the decedent to a qualified heir of the decedent.
- Had been put to a qualified use for five of the eight years preceding the decedent's death and for which there was material participation by the decedent or a member of the decedent's family in the operation of the farm.
The court also observed that the statute does not require that an election pursuant to Section 2032A be made with respect to all or a certain percentage of the qualified real property. Having found the statute unambiguous, the court next determined if the plain meaning of the statute supports or opposes the Regulation. The court observed that the Regulation imposes an additional requirement that the property with respect to which the special-use election is being made must constitute at least 25% of the adjusted value of the gross estate. The court found that this additional requirement was contrary to the plain language of the statute. The court, therefore, held that the portion of the Regulation requiring that a special valuation election be made for at least 25% of the qualified real property was invalid.
This case is not the first to declare that portion of Reg. 20.2032A-8 invalid. In Miller, 3 the same court as in this case reached the same conclusion. The Miller case was not appealed by the IRS, so it is quite possible that this case will also not be appealed. Only time will tell whether the IRS continues to litigate this issue in other circuits or whether the IRS amends the Regulation to remove the requirement that the special-use valuation be made with respect to at least 25% of the qualified real property of the decedent's gross estate.
1 109 AFTR 2d 2012-1439, 2012-1 USTC ¶60641 (DC Ill., 2012).
2 467 US 837, 81 L Ed 2d 694 (1984).
3 61 AFTR 2d 88-1370, 680 F Supp 1269, 88-1 USTC ¶13757 (DC Ill., 1988).
Frank Baldino is an estate planning attorney who co-chairs Lerch, Early & Brewer’s Estate Planning & Probate group in Bethesda, Maryland. His focus is on protecting the assets of high net worth individuals to minimize federal and state tax liability. For more about special use valuations, contact Frank at (301) 657-0175 or firstname.lastname@example.org.
This article originally appeared in the August 2012 edition of Estate Planning, a monthly periodical directed to estate planning professionals that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.