344 Planning and Forecasting
Redemptions to Pay Death Taxes and
Administrative Expenses
Since much of the money to fund this estate tax liability would come from re-
demption of company stock, if Morris had not previously cashed it in, Morris
might well fear the combined effect of dividend treatment and estate taxation.
Of course, if Morris’s estate turned in all his stock for redemption at death,
dividend treatment would appear to have been avoided and redemption treat-
ment under Section 302(b)(3) would appear to be available, since this would
amount to a complete termination of his interest in the company and death
would appear to cut off Morris’s relationship with the company rather convinc-
ingly. However, if the effect of Morris’s death on the company or of other cir-
cumstances made a wholesale redemption inadvisable or impossible, Morris’s
estate could be faced with paying both ordinary income and estate tax rates on
the full amount of the proceeds.
Fortunately for those faced with this problem, Code Section 303 allows
capital gain treatment for a stock redemption if the proceeds of the redemp-
tion do not exceed the amount necessary to pay the estate’s taxes and those fur-
ther expenses allowable as administrative expenses on the estate’s tax return.
To qualify for this treatment, the company’s stock must equal or exceed 35% of
the value of the estate’s total assets. Since Morris’s holdings of company stock
will most likely exceed 35% of his total assets, if his estate finds itself in this
uncomfortable position, it will at least be able to account for this distribution
as a stock redemption instead of a dividend. This is much more important than
it may first appear and much more important than it would have been were
Morris still alive. The effect, of course, is to allow payment at long-term capi-
tal gain rates (rather than ordinary income tax rates) for only the amount re-
ceived in excess of the taxpayer ’s basis in the stock (rather than the entire
amount of the distribution). Given that the death of the taxpayer prior to 2010
increases his basis to the value at date of death, the effect of Section 303 is to
eliminate all but that amount of gain occurring after death, thus eliminating
virtually all income tax on the distribution. This step-up of basis will be signif-
icantly less generous for taxpayer ’s dying after 2009.
Of course, assuring sufficient liquidity to pay taxes due upon death is one
thing; controlling the amount of tax actually due is another. Valuation of a ma-
jority interest in a closely held corporation is far from an exact science, and the
last thing an entrepreneur wishes is to have his or her spouse and other heirs
engage in a valuation controversy with the IRS after his or her death. As a re-
sult, a number of techniques have evolved over the years which may have the
effect of lowering the value of the stock to be included in the estate or, at least,
making such value more certain for planning purposes.
Family Limited Partnerships
One such technique that has recently gained in popularity is the so-called fam-
ily limited partnership. This strategy allows an individual to decrease the size