IRS ISSUES DISCOUNT GUIDANCE FOR FAMILY LIMITED PARTNERSHIPS

FLP Guidelines Issued
In an action that was little-noted at the time, the IRS, on October 18, 2006, issued Appeals Settlement Guidelines for family limited partnerships and family limited liability corporations (FLPs). These guidelines deal with a number of issues that frequently arise in estate and gift tax audits of transfers of FLP interests. We will focus our discussion here on what the IRS had to say in these guidelines on the issue of discounts used in the valuation of such entities. A copy of the guidelines can be found here.

Background
In the early 1990’s, estate planners began using FLPs to hold, manage and transfer business assets such as real estate, securities and operating companies. The IRS often challenged the validity of such arrangements on a number of grounds. In cases where they were not successful in setting aside the FLP’s existence for tax purposes, they would shift their focus to the question of whether the correct valuation discount was applied to the fair market value of the underlying assets in order to value the FLP interests.

The Government’s position is that under certain circumstances, there should be minimal or no discounts applied to the pro rata value of the assets held by the entity. Taxpayers, on the other hand, claim that the fair market value of the transfers are substantially less than the underlying pro rata value of the assets held by the entity. Taxpayers cite discounts for minority interest, lack of marketability and sometimes portfolio composition, to reduce the value of the assets transferred.

Analysis of Cases
The IRS analyzed five Tax Court cases in its discussion of the discount issue. Knight v. Commissioner, 115 T.C. 506 (2000), involved a Texas limited partnership funded primarily with cash, municipal bonds, and real property. The Court allowed only a 15% overall discount for lack of marketability and minority interest. [Read More]