Earlier this year several Warner attorneys attended the annual Heckerling Institute on Estate Planning, the country’s most well-respected educational event for professionals working in the trusts and estates area. The programs offered in-depth coverage of important court decisions, tax law changes and other developments in wealth planning.

In this first of two blog posts, we wish to share some of the conference’s relevant takeaways for high net worth clients and family offices on “hot topics” related to valuation issues.

1. Are Life Insurance Proceeds Owned by and Payable to a Company Included in the Value of Stock in a Shareholder’s Estate?

Federal Circuit Courts differ on this concept, sending a case on this question, Connelly v. United States, U.S., No. 23-146, to the U.S. Supreme Court.

• In Connelly, an Eighth Circuit case, the IRS disagreed with the redemption value claimed on the estate tax return of a deceased owner of a closely held business, because the valuation of the decedent’s shares did not take into account the value of the proceeds from the company-held life insurance policy that had been purchased to cover a redemption of the decedent’s interests.

• Although the Eleventh Circuit has ruled that company-held life insurance proceeds do not increase the value of a company’s stock, the Eighth Circuit ruled to the contrary, holding that the fair market value must include the proceeds from the company-held life insurance. The U.S. Supreme Court ruling on this case will resolve this question.

The takeaway: Owners of closely held companies need to give careful thought to the ownership and beneficiaries of life insurance policies on the company owners’ lives.

2. S Corporation Tax Affecting

Tax affecting is an approach to valuation that reduces the value of an S corporation by assuming a hypothetical corporate tax rate has been applied (to take into account that the owners will pay the tax at the individual rate on any pass-through income from the business). Multiple cases centering on the valuation of S corporation shares using tax affecting have been decided recently, but these decisions are not consistent or general enough to provide a solid path forward. In the most high-profile of these cases, Cecil v. Commissioner (TC Memo 2023-24), the U.S. Tax Court upheld the use of tax affecting as appropriate under the circumstances of the case but stated: “We are not necessarily holding that tax affecting is always, or even more often than not, a proper consideration for valuing an S corporation.”

The takeaway: In determining the value of your S corporation, it is important to rely upon an experienced valuation expert.

3. Eliminating Valuation Discounts on Partnerships

Normally, we are looking to take advantage of transfer restrictions and the illiquidity of closely held interests to obtain minority interest and lack of marketability valuation discounts for planning purposes. However, in cases where estate tax will not be an issue (i.e., total estate assets under the current estate tax exemption amounts), it might be better not to have valuation discounts apply to closely held business interests because there will be a greater “step-up” in basis for those interests upon death.

The takeaways: If this type of planning would make sense for any member of your family, there are ways to eliminate valuation discounts. For example, a limited partnership could be converted to a general partnership. If this technique is used, careful consideration must be given to maintaining creditor protection. You also must confirm whether state law directs that any general partner may leave the company at will and that the liquidation value is the value of the company as a going concern.