June 09, 2008
The Tax Court in the latest of a long line of valuation cases has ruled on the transfer tax value of an interest in a closely held business. In the case, Astleford v. Commissioner, the interests were limited interests in a family limited partnership (FLP). Its significance lies in the size of the discounts and the determination of the gift tax value of an interest in an FLP when the FLP owns interests in other partnerships.
The taxpayer's deceased spouse had created a number of entities that held interests in real estate, the largest interest being a 50 percent general partnership interest in a partnership (GP) that held approximately 3,000 acres of land. The remaining interest in the GP was held by a person who was unrelated to the taxpayer's deceased spouse. The partnership agreement provided that no partner could transfer his or her interest in the GP without the consent of all partners. The taxpayer and her deceased spouse set up separate revocable trusts during their lives and placed their assets, including their various real estate interests in the trusts. The taxpayer's spouse died approximately three years later, and his residual estate was distributed to a marital trust over which the taxpayer had control.
After her spouse's death, the taxpayer created an FLP making an initial transfer of property to the FLP in exchange for a 10 percent general interest and a 90 percent limited interest. On the same day she gifted the 90 percent limited interest to her three children in equal shares. The following year, the taxpayer made additional transfers of her real estate holdings to the FLP, including her "right and interest" in the GP. The taxpayer then made transfers of limited interests in the FLP to the three children sufficient to reduce her interest back down to 10 percent. The IRS audited the gift tax returns of the taxpayer for the two years in which she reported the gifts of the FLP interests to her children and significantly increased the value of the transferred interests.
The first issue the Tax Court addressed was whether the general interest in the GP the taxpayer transferred to the FLP was a partnership interest or an assignee interest. With little analysis, the Tax Court held it was a partnership interest under the "substance over form" doctrine even though the partnership agreement of the GP prohibited such a transfer without the consent of all of the partners of the GP.
The Tax Court then reviewed the appraisals to determine the value of the general interest in the GP transferred to the FLP and the limited interests in the FLP transferred to the taxpayer's children. After picking and choosing from the various valuations the Tax Court felt were appropriate, it applied a 30 percent discount to the general interest in the GP (for lack of marketability and lack of control). It then determined that a 16.17 percent discount for lack of control and a 20 percent discount for lack of marketability (for a combined discount of 33.97 percent) applied to the limited partnership interests in the FLP transferred in the first year and a 17.47 percent discount for lack of control and a 20 percent discount for lack of marketability (for a combined discount of 35.63 percent) applied to the limited partnership interests in the FLP transferred in the following year.