In this estate case, the valuation provided with the estate tax return was based on an assignee interest claiming discounts for lack of control and lack of marketability. The decedent formed a limited partnership in 2008 with the purpose to manage and preserve the assets. The assets of the limited partnership consisted of marketable equity securities, municipal bonds, and mutual funds. The decedent owned an 88.99% limited partner (LP) interest. The partnership was managed by a General Partner (GP) owning a 1% GP interest. The remaining LP interests were held by the decedent’s children. The decedent’s daughter managed the GP.
The partnership agreement allowed for 75% or more of the limited partners to remove and replace the GP. The admission of additional limited partners also required approval of 75% of the limited partners. Upon written agreement of 90% of the partners, limited or general, the partnership could be terminated.
Certain transfer restrictions were in place including the approval of the general partner for any limited partner to sell or assign its interest. An “unadmitted assignee” could collect distributions but had no voting rights or rights to any information or data from the partnership including the ability to inspect the books. An assignee could become a substituted limited partner if the assignee met three conditions of the partnership agreement: 1) consent by the General Partner; 2) the interest transferred was a permitted transfer as defined in the agreement; 3) the transferee executed all documents necessary to confirm the transferee was bound by the partnership agreement.
After formation of the limited partnership, the decedent transferred via an “Assignment of Interest” (AoI) his full 88.99% limited partner interest to a revocable trust. The AoI designated the decedent as the assignor and the revocable trust as the assignee. The AoI transferred “all and singular the rights and appurtenances thereto in anywise belonging.” The trust agreed to be bound by the partnership agreement. The decedent’s daughter signed the agreement as representative of the General Partner of the partnership.
The decedent passed in May 2011. The valuation of the interest attached to the estate tax return valued an assignee interest with discounts totaling 37.2% including lack of control, lack of marketability and lack of liquidity. The estate tax valuation was for about $4.6 million.
The IRS issued a notice of deficiency of close to $500,000 using a limited partnership value of $6 million.
The estate filed suit and proceeded to tax court. The Tax Court noted that in federal estate and gift tax cases, the doctrine of substance over form applies. The Tax Court found that the interest transferred was a limited partner interest not an assignee interest. Although the transfer agreement was an “assignment” the agreement gave the trust all rights of ownership of the limited partner interest. The court also determined that the transfer met all conditions per the partnership agreement to be admitted as a substituted limited partner noting that the daughter signed in the capacity of the General Partner, thereby agreeing to the transfer.
Since the Tax Court determined the interest to be a limited partner interest, it was also in agreement with the IRS appraisers determination that a lack of control discount was not applicable given the percent interest in question had the ability to remove and replace the General Partner. Both experts had applied a discount for lack of marketability (DLOM) in determining value. The court agreed that the application of a DLOM was appropriate but once again agreed with the IRS’ determination of the DLOM percent given it was based on a limited partner interest.
The estate appealed the case to the 5th Circuit Court of Appeals. The 5th Circuit agreed with the Tax Court’s determination of a limited partner interest noting the assignment lacked economic substance outside of tax avoidance. The court further said “without genuine nontax circumstances present, the Assignment is the functional equivalent of a transfer of a limited partnership interest.”
Given its agreement with the characterization of the interest with the Tax Court, the 5th Circuit affirmed the Tax Court’s valuation.
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Melissa E. Loughlin-Sines, CPA, CFE, CVA, CFF, ABV