This case is about the estate of Ms. Warne, who died a domiciliary of California. During her lifetime, Ms. Warne and her husband executed the Warne Family Trust, which became the majority member of various family limited liability companies (LLCs). Ms. Warne, as trustee of the Warne Family Trust, managed all of the LLCs. Ms. Warne’s husband predeceased Ms. Warne. Upon the death of Ms. Warne, the terms of the Warne Family Trust stated that all the LLC interests held by the Warne Family Trust, other than the interests held in Royal Gardens LLC, were to be distributed to family members. Royal Gardens LLC was a single-member LLC, with the Warne Family Trust as the sole member. It held a mobile home park. Pursuant to the terms of the Warne Family Trust, a 75% interest in Royal Gardens LLC was to be distributed to the Warne Family Charitable Foundation, a private family foundation that qualified as a charity under 501(c)(3) of the Internal Revenue Code; and a 25% interest in Royal Gardens was to be distributed to St. John’s Lutheran Church. On Ms. Warne’s timely filed federal estate tax return, her estate took a 100% charitable deduction for Royal Gardens LLC.
The IRS audited Ms. Warne’s estate tax return and found that Ms. Warne’s estate had undervalued all of the estate’s LLC interests, that the estate took an excessive charitable deduction, and that the estate owed additional estate taxes. The executor of Ms. Warne’s estate objected to these findings. During the course of the audit, the IRS and Ms. Warne’s estate agreed that the value of Royal Gardens LLC was $25,600,000. The value of Ms. Warne’s interests in the other LLCs remained disputed throughout the trial. The court ultimately valued those LLC interests, relying on different portions of the appraisals submitted by the parties. Although the valuations were an important part of the ultimate findings, they are not the concern of this review.
The remaining issue in this case was the 100% charitable deduction that Ms. Warne’s estate took for the charitable distributions of Royal Gardens LLC. The IRS maintained that Ms. Warne’s estate should not get a 100% deduction for the value of Royal Gardens LLC, because the deduction should have been discounted for a lack of control and marketability. Ms. Warne’s estate claimed that it should receive a complete charitable deduction for the value of Royal Gardens LLC, because the entirety of Royal Gardens LLC was being distributed to charity, regardless of the fact that the interests in Royal Gardens LLC were divided among charities. The court found that the estate could not claim a full deduction for Royal Gardens LLC.
According to the opinion, there are two different valuation determinations that need to occur when an LLC interest is included in an estate and being distributed from the estate to charity. The first is the inclusion value. When valuing the asset for estate inclusion purposes, the valuation should reflect the value to the estate, regardless of who the donees of the interest are. In this case, Royal Gardens LLC was valued at $25,600,000 without any discounts, as the entirety of the LLC was held by the Warne Family Trust.
The second valuation is used to determine the deduction for the distribution to a charity. A decedent may only take a deduction for the value that is actually received by the charity, which is not necessarily the value of the interest in the estate. In this case, because the estate’s interest in Royal Gardens LLC was distributed to multiple charities, the estate needed to take discounts for lack of marketability and lack of control when determining the charitable deduction available to the estate. Ultimately, the parties stipulated that a 27.385% discount was appropriate for the interest donated to St. John’s Lutheran Church (the 25% interest) and that a 4% discount was appropriate for the interest donated to the family foundation (the 75% interest).
Although this case demonstrated how discounts can be used by the IRS to limit charitable deductions taken on estate tax returns, it also gives insight to practitioners as to how to avoid this issue. If Ms. Warne’s estate had left the entirety of Royal Gardens LLC to a donor-advised fund, with a letter of intent stating that it was her wish that the donor-advised fund distributed the interests in Royal Gardens LLC to the family foundation and the church in the percentages listed above, presumably the court would have allowed the 100% charitable deduction, because no discounts would be available, as the donee of the Royal Gardens LLC would be a single charitable entity.
Molly R. Soiffer is an attorney in the law firm of Bove & Langa PC, located in Boston. Her practice is focused on estate planning and estate administration, which includes advising clients on wealth preservation, incapacity, domestic and international estate planning, gift transaction planning, preparation of gift and estate tax returns, business succession planning, prenuptial agreements, trust administration, and probate administration. Soiffer obtained her J.D. and LL.M. in Taxation from the Boston University School of Law and is licensed to practice law in Massachusetts, New York and New Hampshire. She is also the chair of the Professional Advisors Network for The Boston Foundation and the vice chair of the Governance Committee for the Boston Estate Planning Council.