The Valuation of Promissory Notes
When it comes to promissory notes, the IRS treads heavy but carries a small stick for want of contradicting itself. In the income tax sphere, where the deduction to income resulting from the forgiveness of a loan balance to a not-for-profit entity is at issue, the IRS wants a low value. In the estate and gift tax sphere, the IRS wants a high value. 26 CRF § 20.2031-4 states the following: “The fair market value of notes, secured or unsecured, is presumed to be the amount of unpaid principal, plus interest accrued to the date of death, unless the executor establishes that the value is lower or that the notes are worthless.” In other words, the burden is on you to show that the note’s face value as of the valuation date is not reflective of its fair market value. For estate and gift tax, the primary issue is whether it is a bona fide note or a gift masquerading as a note. An unsecured promissory note at the AFR with interest only payments issued to a son will look suspicious to the ...