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Recent family limited partnership case divides Tax
Court
In McCord
v. Commissioner (120 T.C. No. 13, May 14, 2003), both the IRS and the
donors agreed to the fair market value of the partnership’s underlying
assets. But the parties diverged about the valuation discount amount, the
nature of the gifts and whether to uphold the gifts’ "defined
value" formula. Despite dissenting opinions, the Tax Court came to the
following conclusions:
Valuation discounts reduced. The taxpayer’s expert believed the gifts
warranted a 22% minority interest discount (based on net asset value
discounts for publicly traded closed-end mutual funds and real estate
investment trusts) and a 35% marketability discount (based on pre-IPO and
restricted stock studies). Conversely, the IRS’s expert argued that these
discounts should be 8.34% and 7%, respectively.
In terms of the minority interest discount, the IRS’s expert used market data
closer to the valuation’s "as of" date and argued that the family
limited partnership (FLP) was similar to a new investment fund, which
typically trades at lower discounts from net asset value.
When it came to the marketability discount, the IRS adamantly objected to
deriving marketability discounts from pre-IPO and restricted stock studies.
Instead, the IRS’s expert relied on a "private placement approach,"
which quantified the limited partner interests’ illiquidity rather than its
lack of marketability.
Although the Tax Court was "impressed by portions of the [IRS expert’s]
analysis," it found both sides’ arguments flawed. So, the court arrived
at a compromise of 15% for the minority discount and 20% for the
marketability discount. The court also held that it was appropriate to reduce
the gifts’ value by the amount of gift tax donees will pay — but not for the
speculative estate tax the donees might incur if either donor died within
three years of the gifts.
Economic interests (rather than actual partnership interests) gifted.
The Tax Court upheld the taxpayers’ assertion that they transferred only
their economic rights (as opposed to full partnership interests) when they
gifted interests to their four children, trusts on behalf of their children
and two charities. Accordingly, the court agreed that the gifts’ value was
less than the corresponding value of the limited partner interests.
The court’s finding was based on several important facts, including (1) that
the partners had not consented in writing to the admission of additional
partners (in accordance with the partnership agreement) and (2) that the
partners had historically followed the FLP agreement (distinguishing this case
from Kerr v. Commissioner (113 T.C. 449, 1999)).
"Defined value" formula disregarded. To insulate their gifts
from IRS audit, the donors entered into an assignment agreement that included
a formula clause specifying that the children (and their trusts) were to
receive gifts totaling approximately $7.04 million. According to the donor’s
"defined value" formula, any value greater than that amount should
be assigned to two charities and was, therefore, subject to a charitable
deduction.
Because there was a separate agreement assigning one of the charities a 3.62%
limited partnership interest, however, the additional $2.8 million of value
(resulting from the reduced valuation discounts) did not qualify for a
charitable deduction. Minus this separate agreement with the charity, the Tax
Court would have been required to rule on the legitimacy of the donor’s
defined value formula.
As more donors employ this strategy to insulate their gifts from IRS
repercussions, the Tax Court may be forced to rule on this controversial
issue.
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