On July 21, 2008, in its Internal Revenue Bulletin 2008-29, the IRS issued Revenue Ruling 2008-35, which addressed "whether an interest in a restricted management account (RMA) will be valued for transfer tax purposes without any reduction or discount for the restrictions imposed by the RMA agreement."
The IRS answer: Yes -- that is, no discount.
On July 28, 2008, fellow practitioner Robert Wolf, Esq., of Pittsburgh, PA, drew this Ruling to the attention of the readers of his emailed P & T Hot Tips. He gave me permission to post his comments, which I have edited somewhat.
Bob puts Revenue Ruling 2008-35 into context, and speculates about its effects:
Over the years we have heard many ideas suggested by esteemed estate planners that seem a little too good to be true, such as the Family Limited Partnership, where the donor could keep control of the family business but effectively transfer most of the value out of her estate, and many others.Bob commented accurately about the past promotion of restricted management accounts as a device proposed to obtain a valuation discount on a federal tax return. For example, see "The Restricted Management Account – An FLP Alternative" by Andrew T. Wolfe, CPA, JD, LLM; and "Restrictive Management Accounts" by Nathaniel E. Clement, which includes examples posed by noted estate planning attorney Roy Adams, of Chicago.
One of these is the restricted management account that locks the client's funds away for a number of years, partly to give the investment manager the freedom to invest long term with no worries about investor bailouts, but also to make the assets subject to a substantial discount for federal gift and estate and generation-skipping transfer tax purposes.
Well, we know what the IRS thinks of the Family Limited Partnership deals. The cases brought by the IRS and decided in its favor have made planning with them more difficult and less advantageous.
Nevertheless, esteemed estate planners such as Roy Adams and a number of others have suggested that restricted management accounts ought to work. The argument is that restrictions on liquidity and transfer make their fair market value less than the fair market value of the underlying assets.
Well the IRS doesn't think so, and has issued Revenue Ruling 2008-35 that says so. The IRS ruled that no discount is allowable to such transfers, loosely analogizing the accounts to an IRA account, and also citing Internal Revenue Code Sections 2036 and 2703 for reasons to disregard the restrictions.
The underlying tax policy is that a taxpayer should not be able to create restrictions to his or her own property, and then cite those restrictions as to why the property is less valuable for transfer tax purposes, where a motivating reason for the restrictions is to reduce the transfer tax value of the property.
I have not noticed any cases on this topic, but I guess if you are using an RMA and expect to get a discount on a transfer or for estate or GSTT tax, you will have to get the Tax Court to overturn this Revenue Ruling. You won't get any discount from the IRS without it.
Read the sections of Revenue Ruling 2008-35, per its Table of Contents, to see how the IRS dissected, then declined, the arguments claiming a valuation discount on the Form 706 (Federal Estate Tax Return) for a decedent's assets previously placed into an RMA:
This is the Ruling's holding:
The fair market value of an interest in an RMA for gift and estate tax purposes is determined based on the fair market value of the assets held in the RMA without any reduction or discount to reflect restrictions imposed by the RMA agreement on the transfer of any part or all of the RMA or on the use of the assets held in the RMA.Revenue Ruling 2008-35 was the subject of an article posted online by the law firm McGuireWoods, entitled "IRS to Disallow Valuation Discounts for Restricted Management Accounts" (July 21, 2008).
Accordingly [in the example provide in the Ruling], A’s gift to B in Year 2 is valued at $10X, the full fair market value of the assets transferred into B’s separate RMA. Similarly, the amount to be included in A’s gross estate for estate tax purposes with respect to the RMA is $55X, the full fair market value of the assets in the RMA at A’s death.
Whether one agrees or disagrees with [the] Service, this Revenue Ruling makes the use of RMAs as a substitute for family limited partnerships or limited liability companies far less attractive to customers and clients because of the Service’s repudiation of RMAs as a technique to obtain valuation discounts.For a graphic display of the immediate effect of Revenue Ruling 2008-35, see "Restricted Management Account (RMA)", where the text explaining the pros and cons of this proposed wealth saving device now is greyed-out, under a heading now annotated in bold letters: "TECHNIQUE ON HOLD" [Source of graphic above].
Individuals who have been considering RMAs will now want to consider family limited partnerships and limited liability companies. Despite the attacks made by the Service on family limited partnerships and limited liability companies in the last several years, many family limited partnerships and limited liability companies have withstood attacks by the Service. Thus, family limited partnerships and limited liability companies continue to be viable techniques for obtaining valuation discounts if they are established and managed appropriately.
Individuals currently holding RMAs will now want to pursue other techniques. Of course, if the term of the RMA cannot be shortened, using the assets in the RMA in other techniques may be impossible before the end of the term.* * *