9019 / How can the existence of voting stock create adverse estate tax consequences in the context of a transfer of stock in a controlled corporation?

When a taxpayer transfers property in which certain rights are retained, the value of that property will be included in the estate for estate tax purposes.¹ IRC Section 2036 specifically provides that retaining the right to vote shares in certain corporations constitutes a right that will generate estate tax inclusion even if the shares themselves are actually transferred. This is the case whether the right to vote is retained directly or indirectly (such as through the use of a trust entity or informal agreement).²

In order for the value of transferred voting stock to be included in the original shareholder's estate, the corporation must be considered a "controlled corporation." A corporation is a controlled corporation if, at any time after the transfer and during the three-year period ending on the date of the decedent's death, the decedent-transferor owned at least 20 percent of the combined voting power of all classes of the corporation's stock. In determining the 20 percent ownership test, the family attribution rules of IRC Section 318 apply.³

As a result, the transferring owner will be treated as though he or she owns (1) any stock owned (either directly or indirectly) by the spouse, children, grandchildren or parents, (2) a proportionate share of any stock owned by a partnership or estate in which the transferor is either a partner or beneficiary, (3) a proportionate share of any stock owned by a trust of which he or she is a beneficiary or grantor and (4) stock owned by a corporation if the transferring owner owns 50 percent or more of the value of that corporation. These broad attribution rules expand the reach of IRC Section 2036, making the transfer of nonvoting stock the most effective way to avoid the risk that the value of the shares will eventually be included in the transferor's estate.