As mere appraisers, although well educated and experienced, we do not intend or pretend
to tread on the territory commanded by those trained in the law and/or serving on the
bench. We can, however, make some observations about the current state of affairs from our
appraisal perspective.
The Third Circuit found “no clear error” in the Tax Court’s decision*
returning the decedent’s assets in two family limited partnerships to his gross
estate under Section 2036(a)(1). There had been contributions of practically all of the
decedent’s assets to the partnerships with the family’s understanding that he
would continue to rely on them for his support. The Court distinguished favorable taxpayer
decisions in Church†, Stone‡ and Kimbell, stating
that the transfers did not qualify for 2036(a)’s “bona fide sale” exception
because neither partnership “conducted any legitimate business operations, nor
provided decedent with any potential non-tax benefit from the transfers.”
* T.C. Memo. 2002-246. (9/26/02)
† 85 AFTR2d Par. 2000-428. (1/18/00)
‡ T.C. Memo. 2003-309. (11/17/03)
The IRS successfully used an indirect gift argument where the parents’ funding of
two family limited partnerships with MCI WorldCom stock and their gifts of limited
partnership interests to children’s trusts were found to be “integrated,”
“simultaneous” transactions. The parents’ disregard for certain FLP
formalities and necessary documentation was emphasized in Judge Cohen’s decision.
Interestingly, had the Court ruled in the parents’ favor, stipulated valuation
discounts ranging from 39% to 46% would have applied. Not bad for partnerships owning one
public stock!
A district court decision* that included the full value of a limited partnership’s
assets (cash, securities, oil and gas interests) in the decedent’s taxable estate has
been vacated and remanded. The Fifth Circuit reviewed the facts and concluded that the
“bona fide sale for adequate and full consideration” exception to Section
2036(a)’s inclusion of assets in which there is a retained life interest had been
satisfied. The transfer of assets to the partnership, even with its tax planning motives,
was “in good faith,” was “not a disguised gift or a sham transaction”
and had a “genuine business purpose.” Business reasons included various
advantages of partnership ownership of oil and gas working interests.
This was a win for the taxpayer because a 49% discount had been used in valuing the
limited partnership interests.
*91 AFTR 2d 2003-585. (1/14/03)
These cases considered whether pricing provisions in a buy-sell agreement (Blount)
and a limited partnership agreement (Smith) were binding for transfer tax
purposes. Section 2703(a)(1) requires that a below fair market value pricing provision be
ignored unless it meets each of the three safe harbor exceptions under Section 2703(b),
namely, (1) it is a bona fide business arrangement, (2) it is not a testamentary
disposition for less than adequate consideration, and (3) it is comparable to arrangements
between unrelated parties at arm’s length.
The Blount case involved a failed attempt (by means of a deathbed modification
of a buy-sell agreement) to fix the estate tax value of a controlling block of stock in a
road construction company. Smith is a gift tax case which dealt with a right of
first refusal provision in a limited partnership agreement setting price and terms. More
importantly, the opinions in both cases are useful in understanding what is required to
satisfy the three safe harbor tests.
A provision or agreement which is designed to keep the family in control of the
business will generally be regarded as “bona fide business arrangement.” The
“testamentary device” test involves an inquiry into the facts in existence at
the inception of the agreement. The intent of the parties, the transferor’s health,
the reasonableness of the price, the nature and extent of negotiations, reliance on
outside appraisals, etc., will help determine whether or not an agreement was a
testamentary substitute. The “comparability” test is thought to be the most
difficult to satisfy. According to gift tax regulations*, the test is met if a right or
restriction “conforms with the general practice of unrelated parties under negotiated
agreements in the same business.” The problem is finding such agreements, since they
are not generally made public. However, it would seem that the price determined and/or
methodology used in a qualified business appraisal prepared at the time of the agreement
would be quite relevant and persuasive.
* Section 25.2703-1(b)(4).
The following two Section 2036(a) cases tell us what
“bad facts” convinced the Tax Court to disregard a family limited partnership
and include its assets in the taxable estate:
- The partnership was formed five months before death when decedent was in poor health and
had even attempted suicide.
Estate tax return and partnership income tax returns were
inconsistent in their treatment of decedent’s and brother’s partnership
interests.
Tax Court’s Bottom Line: The decedent’s relationship with her assets never
changed.
Tax Court’s Bottom Line: Nothing changed. The decedent effectively retained the
right to all income generated by the partnerships.
MPI’s restricted stock study to support a discount for lack of marketability
played a prominent role in this case involving the estate tax value of 5.09% of the stock
of a privately held bank. Not only did the IRS place “considerable reliance” on
our study, Judge Thornton used it as well, noting larger discounts for smaller companies
and a central tendency of private placement transactions of 30.05% overall. In view of the
importance given to our study, his conclusion of a 35% discount for lack of marketability
is not surprising.
MPI Securities, Inc.
Investment Banking Services
2004 Assignments
- Advising a health care information systems company in a merger.
- Advising a food products business in a sale transaction.
- Providing financial advisory services to a metals services company.
- Advised a multinational service business regarding a tax-free spin-off.
- Advised a leading consumer products company regarding a proposed merger.
