The use of family limited partnerships as part of a comprehensive estate plan has increased dramatically since the issuance of Revenue Ruling 93-12 permitting valuation discounts for intrafamily transfers of closely held business interests. The opportunity to reduce significantly the transfer tax consequences of a variety of estate planning techniques through the use of closely held entities has caused heightened IRS scrutiny of transactions using family controlled entities. The result has been a steady stream of cases and rulings as well as a lively academic debate about the availability of valuation discounts for transfers involving family limited partnerships in a variety of circumstances, particularly, if the partnership consists largely of marketable securities.
Several recent cases provide favorable guidance for taxpayers in this area. The most favorable is an unreported case, Estate of Church v. U.S., in which the decedent and her children formed a family limited partnership consisting primarily of marketable securities. The decedent and each of her children took back partnership interests proportionate to the fair market value of the assets each contributed.
The Government made several familiar arguments in its effort to avoid the valuation discount claimed by the taxpayer. The Government argued that the decedent made a gift upon formation of the partnership. The amount of the gift would be the difference between the fair market value of the assets contributed and the discounted fair market value of the partnership interest included in the decedent’s estate. Some commentators have argued that a gift can occur for tax purposes simply by loss of value to the donor, even if that value cannot be found in the hands of any donee. Fortunately for taxpayers, the court correctly held that there can never be a gift upon the formation of a business entity in which each investor’s interest is proportionate to that investor’s contribution of capital. Proper structuring upon formation of the family limited partnership is essential to avoid adverse gift tax consequences.
The Government also argued that the decedent’s interest in the family partnership should be evaluated as a direct interest in the assets of the partnership, in effect disregarding the existence of the entity. The Government cited certain statutory authority that it has consistently interpreted to support its position. The court unequivocally stated that it could find no basis in the law to disregard the partnership agreement and the relationships that it created among the parties under State law.
The Government, apparently overconfident, did not submit any valuation evidence. Accordingly, plaintiff’s expert carried the day, resulting in a greater than 50% discount from net asset value for the taxpayer.
In Kerr v. Commissioner, the taxpayers formed two family partnerships and made gifts of limited partnership interests to their children and in trust for their grandchildren. The partnership was funded with bonds, stock and real estate. The Government argued that certain restrictions on a limited partner’s ability to withdraw from the partnership should be ignored for valuation purposes. The Government has consistently asserted that the Internal Revenue Code expressly authorizes its position. The court analyzed the legislative history of the relevant provision and found that the Government’s position was inconsistent with its own regulations. The court held that the statutory provisions apply only to restrictions on the ability to liquidate the entire partnership, not the ability of a limited partner to withdraw from the partnership. If those restrictions are more restrictive than state law, they may be ignored for valuation purposes.
The Tax Court did issue a word of caution, however, in Estate of Reichardt v. Commissioner. In Reichardt, the decedent formed a family limited partnership in which his revocable family trust was the general partner and he was the limited partner. Decedent’s children were co-trustees of the family trust, but did not perform any functions as trustees. The decedent transferred his residence and essentially all his other assets to the partnership. He gave his children each a 30.4% limited partnership interest in the partnership.
Decedent continued to control and manage the assets of the partnership in the exact same manner as he had prior to forming the partnership. He continued to occupy the residence as before without paying rent to the trust or the partnership for use of the residence. He made distributions to himself from the partnership accounts without making distributions to the other partners.
The court found the fact that the decedent conveyed nearly all his assets to the partnership suggested an implied agreement with his children that he could continue to use those assets. Accordingly, the entire partnership was held to be includible in the decedent’s estate for estate tax purposes, notwithstanding the lifetime gifts to his children of limited partnership interests.
The foregoing cases demonstrate that substantial estate planning opportunities continue to exist through the appropriate use of family controlled entities. The desired objectives will not be achieved, however, without careful planning and on-going administration.
We believe we can provide the sophisticated advice and judgment our clients need to make effective use of the opportunities available. Greenberg Traurig has designed a number of innovative techniques designed to take advantage of the law in this important area. We have successfully sustained substantial valuation discounts for properly structured family entities, even when those entities consist primarily of marketable securities. Our shareholders Diana Zeydel and Norm Benford have written an in-depth article that discusses not only the law on valuation, but also tax penalties and the effective use of valuation experts entitled "Valuation Principles and Recent Developments: Practical Guidance for the Estate Planner". This article was presented at the Philip E. Heckerling Institute on Estate Planning and published in ACTEC Notes and the summer 1999 issue of the ABA’s Real Property, Probate and Trust Journal. Copies are available upon request.
© 2000 Greenberg Traurig
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