Tiered Discounts – Theory and Tax Court Record

When it comes to business valuation for estate or gift tax purposes, there is perhaps no single topic that evokes stronger opinions than tiered discounts. Taxpayers love them and the IRS hates them. Situations giving rise to tiered discounts are frequently encountered in the structures used in estate planning. Appraisers must opine on the magnitude of such discounts and provide a rational explanation supporting that opinion. Unfortunately, there is virtually nothing in the financial valuation literature that speaks to this issue.

The determination of the fair market value (FMV) of fractional equity interests for estate or gift tax purposes is one of the most documented and researched topics of modern business valuation theory and practice. A not-insubstantial part of the body of knowledge of business valuations for federal estate and gift taxes relates to the subject of valuation discounts. Oft-cited textbooks on business valuation are noticeably silent when it comes to the subject of tiered discounts.

It comes as no surprise that, in gift and estate tax controversies, taxpayers’ appraisal experts argue for much higher discounts than the experts proffered by the IRS. The courts are in the unenviable position of determining a result that is most correct based upon the evidence. Much of the evidence presented by business valuation experts in these cases falls into the ipse dixit category. In fact, the only evidence cited by the courts in their tiered discount opinions is the record of other courts having previously considered the issue.

Several U.S. Tax Court cases exist that provide explanations for acceptance or disallowance of tiered discounts. Upon further examination, however, the explanations thus far proffered shed very little light on the subject.

The subject of this article is the theory of tiered discounts—not a “how to” application guide. Perhaps that will follow. The discounts provided herein for the various examples are purely arbitrary and for illustration purposes only.

For more information see William Harper Frazier "Tiered Discounts – Theory and Tax Court Record", ABA Probate and Property Journal, Jan/Feb 2025.