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 Rev. Rul. 78-58

1978-1 C.B. 279

Section 2013 -- Credit for Prior Tax

IRS Headnote

Credit for tax on prior transfers; valuation of property. For purposes of computing the credit for tax on prior transfers, stock of a closely held corporation that could have been the subject of a lifetime transfer at any price, but that was subject to a buy-sell agreement under which the legatee was required to and did sell the stock to the remaining shareholders at a specified price that was less than its then fair market value, is valued in the estate of the legatee at the price at which the stock was sold to the other shareholders. Each of the remaining shareholders will be entitled to a credit for tax on prior transfers for a proportionate part of the difference between the specified sale price and the fair market value of the stock.

Full Text

Rev. Rul. 78-58

Advice has been requested as to the proper valuation of property passing to a decedent for purposes of computing the credit for tax on prior transfers provided in section 2013 of the Internal Revenue Code of 1954, under the circumstances described below.

The transferor, A, died testate in 1975. A's will provided that all federal and state estate and inheritance taxes were to be paid out of the residuary estate. A bequeathed his stock interest in X Corporation, a closely held corporation, to B.

The X Corporation stock was subject to a buy-sell agreement that provided that during A's lifetime, A was free to dispose of the stock at any price. Upon A's death, B, as A's legatee, was required under the agreement to offer the stock to the remaining shareholders of X Corporation for a specified price of $25,000. The remaining shareholders were required to purchase the stock at the agreement price. Pursuant to the agreement, which was binding under state law, B sold the stock to the shareholders at the specified price.

On audit of the federal estate tax return filed for A's estate it was determined that the agreement did not fix the value of the stock for estate tax purposes because A could have disposed of the stock without restriction during life. See section 20.2031-2(h) of the Estate Tax Regulations which provides that, for purposes of valuing a decedent's stock interest, little weight will be accorded a price contained in a buy-sell agreement under which the decedent is free to dispose of the stock interest during the decedent's lifetime. The stock was therefore included at $100,000, its fair market value determined without regard to the buy-sell agreement.

B died in 1976. On the federal estate tax return filed for B's estate, the executor claimed a credit under section 2013 of the Code for taxes previously paid with respect to the stock B received from A's estate. The executor asserted that, for purposes of computing the allowable credit, the amount of the value of the transfer from A to B was $100,000, the value of the stock in A's gross estate.

Section 2013(a) of the Code provides for a credit against the federal estate tax for all or part of the federal estate tax paid with respect to the transfer of property to the decedent from a person (designated as the transferor) who died within ten years before, or within 2 years after, the decedent.

The amount of the allowable credit is based on the value of the property transferred to the decedent. Section 2013(d) of the Code provides rules for determining the value of the transferred property. Section 2013(d)(2) provides as follows:

(d) Valuation of Property Transferred.--The value of property transferred to the decedent shall be the value used for the purpose of determining the Federal estate tax liability of the estate of the transferor but--

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(2) where such property is encumbered in any manner, or where the decedent incurs any obligation imposed by the transferor with respect to such property, such encumbrance or obligation shall be taken into account in the same manner as if the amount of a gift to the decedent of such property was being determined.

Example 2, contained in section 20.2013-4(b)(3)(iii) of the regulations, provides the following illustration of this principle:

The transferor bequeathed certain property to the decedent with a direction that the decedent pay $1,000 to X. The value of the property transferred to the decedent is the value of the property reduced by $1,000.

The language of section 2013(d)(2) and the applicable regulations indicates that the value of the property transferred, for purposes of computing the credit for tax on prior transfers, is the net benefit received by the decedent from the transferor. In United States v. Stapf, 375 U.S. 118 (1964), 1964-1 (Part 1) C.B. 553, the Court considered the application of section 812(e)(1)(E)(ii) of the Internal Revenue Code of 1939 (now section 2056(b)(4)(B) of the Internal Revenue Code of 1954). This section pertains to the valuation of property interests passing to the surviving spouse for purposes of computing the marital deduction, and it contains language almost identical to the provisions of section 2013(d)(2). In Stapf, the decedent's spouse, a resident of a community property jurisdiction, elected to take under the decedent's will and allow its terms to govern the disposition of the spouse's community property. The spouse was required to relinquish her community property interest in order to take the bequest. The Court determined that the reference point for valuing a transfer to the spouse under section 812(e)(1)(E) is the "net economic interest" received by the spouse from the decedent-transferor and not the value of the transfer moving from the decedent-transferor. The requirement that the spouse relinquish the community property qualified as an "obligation" imposed by the decedent with respect to the property. Consequently, the value of the property transferred to the spouse from the decedent was the amount by which the property bequeathed to the spouse exceeded the amount the spouse had to relinquish.

The Court's discussion of section 912(e)(1)(E)(ii) is equally applicable to the provisions of section 2013(d)(2). Estate of Sparling v. Commissioner, 552 F.2d 1340 (9th Cir. 1977). See also S. Rep. No. 1622, 83rd Cong., 2d Sess. 467 (1954) stating the Congressional intent that the value of the transferred property under section 2013(d) is to be determined in the same manner as the value of property interests passing to a surviving spouse for purposes of the marital deduction.

In the instant case, the stock A bequeathed to B was subject to an encumbrance imposed by A that required B to sell the stock interest for $25,000. The result is that B received a net beneficial interest worth $25,000 and the stockholders received a net beneficial interest worth $75,000. Consequently, the situation presented is similar to the one presented in example 2 of section 2013-4(b)(3)(iii) of the regulations, quoted above.

As a result of this encumbrance imposed by A, the value of the property transferred to B was only $25,000. Pursuant to the decisions in Stapf and Sparling, the value of the property transferred to B, determined in accordance with section 2013(d)(2) of the Code, is $25,000, the amount received, rather than $100,000, the fair market value of the property transferred from A.

Accordingly, for purposes of computing the allowable credit for tax on prior transfers, the value of property transferred to B is $25,000. Further, each of the stockholders will be entitled to a credit for tax on prior transfers for a proportionate part of the $75,000. See also ??? 20.2013-4(b)(3)(iii), Example 3.