Category: Estates & Gift
Subject: Estate
Title: Valuation of Lawsuit Settlement
IRC Sections: 2031, 7520
Filename: 1303.html
Date Produced: 03/94

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Taxpayer (TP) is the estate of a child. The child was harmed through medical malpractice and there was a judgment in favor of the child which provided for a series of escalating payments over the longer of the child's life or 20 years. Approximately two years into the receipt of payments under the judgment, the child died. The issue is how to value the stream of payments for estate tax purposes.

First, it is apparent that there is no special rule with respect to assets of this type. The situation at hand seems to fall within the catch-all provision of §2031 which provides that the gross estate includes any property in which the decedent has an interest at the time of death. While I was not able to locate any cases with facts similar to those at hand, there are a number of cases involving the valuation of a cause of legal action that existed at the time of the decedent's death and subsequently matured some time later into a settlement or judgment. See, for example, Schnorbach v Kavanagh, 52-1 USTC ¶10,836, (D Mich 1951); and Davis Est. v. Comr., T.C. Memo 1993-115. The existence of these cases strengthens my view that there are no special rules for payments resulting from a judgment or the settlement or a lawsuit.

You expressed concern that if TP were required to include the present value of the payment stream in the gross estate, a very significant estate tax would be due and TP would not have sufficient liquid assets to pay the tax. Based on my experience, lack of liquidity is a common problem with the estate tax system. One of the unwritten principles of the income tax system is the incidence of taxation should coincide with the taxpayer's ability to pay the tax. The estate tax system seems to represent an extreme example of shunning this wherewithal to pay concept. For example, the value of highly illiquid assets such as real estate or the stock of a closely-held business is clearly includible in the gross estate. Executors are frequently forced to sell estate assets in order to raise sufficient cash with which to pay estate taxes attributable to such illiquid assets.

§7520 provides that the IRS will periodically prescribe tables to be used for valuing various kinds of annuities, remainder interests, terms of years, etc. The tables are to include up-to-date actuarial information and present values based on 120% of the federal mid-term rate as of the valuation date of the interest in question. On the surface, it would appear that TP's payment stream should (could) be valued based on such valuation tables, but on closer examination it appears that the escalation feature of TP's payment stream renders the tables useless.

There are numerous examples of valuation of payment streams similar to that to TP. For example, the right to receive mineral royalties or the obligation to pay alimony seems to be similar in nature to TP's circumstances. In those cases, the courts have looked simply to the present value of the payment stream discounted at a reasonable rate. With respect to royalties, see Appeal of Royal Mineral Assn, 5 BTA 1126 (1927); Hightower v Commr, TC Memo 1972-252, 31 TCM 1250, ¶72,252 P-H TC Memo; McAlpin v US, D Miss Aug 7, 1982, 82-2 USTC ¶13,490, 50 AFTR2d 82-6220; Est of Livermore v Commr, TC Memo 1988-503, 56 TCM 525, ¶88,503 P-H TC Memo. Stanton v Commr, TC Memo 1967-39, 26 TCM 191, ¶67,039 P-H TC Memo; and Est of Livermore v Commr, TC Memo 1988-503, 56 TCM 525, ¶88,503 P-H TC Memo. With respect to alimony see Ithaca Trust Co v US, 279 US 151 (1929), 49 S Ct 291, 1 USTC ¶386, 7 AFTR 8856.

Based on the foregoing, it seems reasonable that the value of the payment stream for estate tax purposes should be arrived at by first determining the amount of each payment to be received by TP under the terms of the judgment. Having done so, each payment should then be restated to its present value on the date of the decedent's death (or alternate valuation date, if applicable) using a reasonable discount rate. The aggregate of the present values so computed should represent the estate tax value of TP's payment stream.