9034 / How can a majority or minority interest impact the value of a small business interest?

If a block of stock represents a controlling interest in a corporation, a “control premium” may add to the value of the stock. If, however, the shares constitute a minority ownership interest, a “minority discount” is often applied to the value. For example, in Martin v. Commissioner,¹ discounts were applied to shares of stock representing a minority interest in a holding company that, in turn, held minority interests in seven operating companies. In this case, lack of control over both the holding and operating companies, combined with a lack of marketability (see Q 9028), led the court to allow a combined 70 percent discount in valuing the interests.

A premium may also attach for swing vote attributes where one block of stock may exercise control by joining with another block of stock.² The IRS has valued stock included in the gross estate at a premium as a controlling interest, while applying a minority discount to the marital deduction portion which passed to the surviving spouse.³

However, the fact that an interest being valued is a minority interest does not always mean that a minority discount is available. Courts have held that, even though the interests at issue are minority interests, a minority discount is not appropriate if there is nothing lost through the minority ownership position. For example, in a case where the decedent owned minority interests in five partnerships, no discount was available because the partnership agreement required the partnerships to distribute cash flow annually based on a predetermined formula. Therefore, the majority partners would not be able to prevent or alter the partnership distributions and there was no risk that the minority owner would not receive an annual payout.⁴

If a donor transfers shares in a corporation to each of the donor’s children, the IRS will no longer consider family control when valuing the gift under IRC Section 2512. Thus, a minority discount will not be disallowed solely because a transferred interest would be part of a controlling interest if such interest were aggregated with interests held by the person to whom the interest was transferred who was already a controlling shareholder.⁵

The Tax Court has determined that an estate would not be allowed a minority discount where the decedent transferred a small amount of stock immediately prior to death for the sole purpose of reducing her interest from a controlling interest to a minority interest for valuation purposes.⁶ Also, a partnership or LLC may be included in the gross estate under IRC Section 2036 without the benefit of discounts if a decedent transfers all of his or her assets to the partnership or LLC and retains complete control over the income of the partnership or LLC.⁷

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Planning Point: With the enlargement of the estate tax exemption for 2018-2025 (and potentially beyond), many planners are now seeking to reverse strategies that would have permitted clients to claim valuation discounts in their estate plans. Valuation discounts are primarily important in reducing the value of a client’s taxable estate—usually in the small business context. However, if the client is unlikely to be subject to the estate tax at all, use of a valuation discount can cause the client to forgo a portion of the basis adjustment to which his or her heirs would otherwise be entitled. A greater upward basis adjustment can provide income tax savings. As a result, clients who do not expect to be subject to the estate tax may wish to revisit their estate planning to ensure the largest possible basis adjustment, which may require reversing previously implemented strategies. Of course, the potentially temporary nature of expanded transfer tax exemption must be taken into account.

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