Implications of Minority Interest and Stock Restrictions In Valuing Closely-Held Shares

The federal estate and gift taxes levy on the gratuitous transfer of wealth by both testamentary and lifetime disposition. The amount of the tax depends on the value placed on the property transferred by the decedent or donor. When the property transferred consists of shares of stock in a closely held corporation, there often exists no ready market to help in valuation. As a result, the value of the shares used to compute the federal estate or gift tax must be determined first by appraising the value of the enterprise, and then by allocating some portion of that value to the shares in question. Occasionally, the value placed on these shares will differ from the proportionate value of the enterprise represented by them. This article deals with two instances of such variation in value from the proportionate interest of the shares in the closely held enterprise. One concerns the minority position of the recipient relative to other stockholders. The other concerns shares which are not freely transferable. Since both of these factors limit the shareholder\u27s ability to realize fully on the value of the shares, a discount is frequently applied to such stock when computing gift and estate taxes

Divorce, Tax-Style

In response to the sham divorce tactic, the IRS recently issued Revenue Ruling 76-255. The author, professor of law at Boston University School of Law, although sympathetic with the IRS\u27s position in the Ruling, poin4s out situations where the divorce-remarriage may possibly be considered valid because of the existence of nontax effects

Abortion to Aging: Problems of Definition in the Medical Expense Tax Deduction

Administration of the medical expense deduction has generated its share of litigation and rulings. The major areas of dispute center on two questions. By far the more important question is how to distinguish deductible medical expenses from other expenses that should be characterized as personal, living, or family expenses. The statutory definition of medical care is a broad one, encompassing amounts paid for diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. \u27 10 It also includes transportation to obtain medical care. Because normal expenses of a personal nature, such as nourishing food, fall literally within this language, an overbroad construction of the deduction would swallow up many otherwise nondeductible living expenses. The need to distinguish medical from personal expenses arises in two contexts. First, some expenditures provide a measure of medical improvement to the recipient but also may be sought by other individuals in the ordinary course without health care motives. Thus, the regulations have long provided that a relaxing vacation, although beneficial for one\u27s general well-being, is not a deductible medical expense.12 Second, a taxpayer may pay for services or procedures outside the ordinary course of medical treatment but which provide little amusement, pleasure, or personal gratification as generally understood. As to the latter payments, the Internal Revenue Service tends to allow deductions liberally; it does not require the taxpayer to follow orthodox medical procedure as a condition of deductibility.13 For example, acupuncture treatment is deductible even though the practice may not be sanctioned by practitioner licensing or long prior usage. A second issue is whose medical expenses a taxpayer may deduct. The statute permits a taxpayer to deduct his own medical care expenses as well as those of his spouse and dependents. Dependency is determined in accordance with the rules for personal exemptions.15 Because the cost of medical care easily can exceed the $750 deduction for an additional exemption, the importance to the taxpayer of determining dependency status may be far greater for this purpose than for personal exemptions. A third issue-when to deduct an expenditure for medical care which will benefit the taxpayer over several years-has not been a major source of dispute. The regulations 16 depart from the usual capitalization rules applicable to trade or business property. For the latter, deductions for capital expenditures generally must be spread over the useful life of the asset through depreciation rather than deducted at the time of expenditure. 17 Capital items purchased for health care, however, entitle the taxpayer to- a current deduction of the full amount of the expenditure, reduced only by the enhancement in value to other property by reason of the expenditure. The regulations use as an example a taxpayer who installs an elevator in his home on the advice of a physician so that his wife, who has heart disease, will not have to climb stairs.18 If the installation cost is$1000, and the residence increases in value by $700, the taxpayer may deduct the difference of$300 when the expenditure is made. In following a current deduction rule, the regulations eliminate a host of depreciation-related issues such as questions of useful life and salvage value. In addition, they implicitly foreclose inquiry into whether the taxpayer makes some nonmedical use of the improvement and obviate the need to allocate between medical and other uses. The taxpayer is also spared the recordkeeping necessary to keep track of the deductions over time. Presumably, the initial requirements-that the capital expenditure be directly related to medical care and that enhancement to other property be subtracted-are deemed under the regulations to provide adequate safeguards against abuse. This paper explores the resolution of these definitional problems in a number of factual settings, arranged in order of the individual\u27s life cycle. The problem of personal expenditures appears in each section, dependency in sections II and VII, and capital expenditures in section VI

The Tax Benefit of Bliss

In recent years the Supreme Court has limited its substantive decisions in federal income tax matters.I For the most part, the handful of tax cases it has considered each year deal with collection, liens, or other issues peripheral to doctrinal development in the tax area.2 The Court\u27s recent decision in Diedrich v. Commissioner,3 however, dealt with a realization question involving net gifts; and its grant of certiorari consolidating the cases of Bliss Dairy, Inc. v. United States and Hillsboro National Bank v. Commissioner4 promises a continuing interest in substantive tax law. Bliss Dairy will enable the Court to resolve a conflict in the circuits over the application of two tax doctrines-the tax benefit rule and the General Utilities doctrine-to corporate liquidations. Hillsboro National Bank also involves the application of the tax benefit rule, but in a different corporate setting. The tax benefit rule requires a taxpayer to include in income the amount of a deduction taken in a prior year for costs and expenditures that are not ultimately incurred. In a tax system based on an annual reporting period, taxpayers claim deductions for a particular year based on actual cash expenditures or items accrued. But subsequent events sometimes deprive a transaction of its deductible character. For example, suppose in year one a taxpayer donates property to a charity and claims a deduction for its fair market value. Then in year five the charity unexpectedly returns the property. Under the tax benefit rule the taxpayer must include in income for year five the amount of the recovery.5 Although Congress never expressly enacted this rule, section 111 of the Internal Revenue Code6 establishes the principle indirectly. This section allows the taxpayer to exclude from income any portion of a recovery if it did not give rise to an earlier tax benefit. Thus, in the example above, if the taxpayer had no taxable income from which to deduct the amount of the donation in year one, section 111 would exclude from income the return of the property in year five. The tax benefit rule thus operates to correct the initial deduction, but only if the taxpayer earlier enjoyed a reduction in tax liability. The other principle under consideration in Bliss Dairy, the General Utilities doctrine, also arose initially in the courts. It provides that a corporation recognizes no gain when it distributes appreciated property to its shareholders, whether as a dividend or other distribution from an ongoing corporation or as a distribution in partial or comp!ete liquidation. 7 Section 311(a) now applies this rule to distributions,8 and section 336(a) provides for nonrecognition in complete or partial liquidations. 9 In both instances, the Code and the case law create a number of exceptions. 10 The problem Bliss Dairy presents-and that this Article attempts to resolve-is the extent to which the tax benefit rule modifies the Code\u27s General Utilities nonrecognition provisions in a liquidation, so as to require an inclusion in the corporation\u27s income of an amount previously deducted. On the other hand, Hillsboro National Bank presents a more orthodox application of the tax benefit rule, and the case is susceptible of an easier solution

Artists, Art Collectors and Income Tax

The federal income tax law treats artists and art collectors differently. Similar transactions concerning artworks produce disparate income tax results, depending on whether they involve the artist or the collector. On balance, these results seem to favor the collector over the artist. But notwithstanding the dismay of some artists and their advocates, the differences in result flow, in the main, from the differences in the source of the taxpayer\u27s investment in the work. The collector buys the work with after-tax income. Any gain is properly treated as an investment return and is eligible for capital gain benefits.\u27 The collector, however, does not escape questions of tax characterization entirely. Often his motive in acquiring the work reflects the happy congruence of personal gratification and investment opportunity. If\u27 the former dominates, the transaction loses its profit-seeking character and, with it, the deductibility of losses and certain expenses. with it, the deductibility of losses and certain expenses. 2 In contrast, the artist acquires his work only partly with tangible investment, such as canvas and paint or clay; he adds his personal efforts which often are the chief source of the work\u27s value. The artist pays no tax on this value he creates with his services until he realizes income in some way, as by the sale of the work. The return to the artist is partly personal services income and partly payment for holding the work after completion, a kind of investment return we shall examine further. 3 In addition, the artist\u27s deduction of certain expenses and losses may depend on his state of mind; like the collector, he may find it necessary to distinguish his profit-seeking activities from his pleasurable ones. This Article traces these income tax distinctions through a number of common transactions, including sale of property at a gain, sale of property at a loss, expenses incurred to produce or preserve the property, exchanges, and gifts to charity. In each case, the treatment of collectors and artists is contrasted and the appropriateness of any differences is considered. This Article limits the analysis to artworks embodied in the form of unique tangible personal property, primarily painting and sculpture; although some of the discussion bears on authors, book collectors, and others, this Article does not deal with the tax problems of their transactions. As we will see, most of the differences in treatment derive from the well-established tax differentiation between services income and gains on the sale of property. A few instances, however, go beyond this justification. In Part V, I will propose two changes, one that enhances the tax position of artists and one that limits the benefits currently available to collectors

The Control Test for Limited Partnerships

Under the Uniform Limited Partnership Act, a limited partner may become generally liable if in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business. Although the Act is now over fifty years old, no satisfactory standard of control has been enunciated, and no definition of the rights and powers of a limited partner has been forthcoming. Mr. Feld examines the ambiguities in the statutory language and the dilemma in which they place counsel seeking to advise his clients, and concludes that the Act is due for an overhaul

Another Word on Child Care

Professors Schaffer and Berman have written a stimulating brief in support of a deduction for child care expenses in computing federal taxable income. But, in addition, by the range of considerations which their article takes into account, it illustrates the difficulty in opting for deductibility or nondeductibility on the basis of a rational consideration of income tax policies. The difficulty derives primarily from the fact that child care expenditures partake of both a personal (consumption) element and a business (income earning) element.1 To the extent it represents the latter, it does not represent personal income appropriately subject to tax; to the extent it represents the former, it does.

Deductibility of Expenses for Child Care and Household Services: New Section 214

It is increasingly common to find families composed of husband, wife and young children, where both husband and wife are gainfully employed. For some, this pattern is regarded as preferable to the older ideal family, where the husband was the sole breadwinner and the wife cared for the children, performed household chores and perhaps engaged in social or charitable activities. Where both spouses are gainfully employed, it is often necessary for the family to employ household help to care for the children and do the housework. These expenditures are necessary to the gainful employment of both spouses in the sense that if they were not made, at least one spouse could not be employed. Yet the expenditures are for services which ordinarily would be regarded as personal; families may employ a housekeeper even if one spouse stays at home. From its inception the federal income tax has allowed a deduction for ordinary and necessary expenses paid or incurred in carrying on a trade or business.1 Since 1942 ordinary and necessary expenses paid or incurred by an individual for the production or collection of income have also been deductible.2 Just as fundamental, however, has been the principle that no deduction is allowed for personal, living or family expenses.3 Apart from a narrow exception enacted by Congress in 1954 and enlarged in 1964,4 the courts have uniformly treated child care and household expenses as personal and therefore nondeductible. 5 The Revenue Act of 1971 substantially liberalized the tax treatment of expenditures for household services and for child and dependent care, where incurred to enable the taxpayer to be gainfully employed.6 While the act alleviates much of the financial burden of out of pocket employment related costs for many taxpayers, the deduction remains limited by questionable restrictions and a number of administrative issues (pending promulgation of regulations) remain unanswered. Yet in some respects the new provision may be overbroad, permitting too much to be deducted