February 2010 | Issue 43
A Family Limited Partnership Roadmap
The Murphy family, during the 1990s, established a family limited partnership (FLP) to hold a sizeable portion of the family’s holdings of stock and real estate. Mr. Murphy died in 2002. His estate paid over $46 million in taxes, but the IRS claimed $34 million in deficiencies. The parties ended up in District Court in Arkansas (Murphy v. U.S., 2009 WL 3366099 (W.D. Ark.)(Oct. 2, 2009). The estate went home from court with a refund of $41 million.
The Murphy story provides a roadmap on how it is possible to establish and sustain an effective family limited partnership. It also illustrates the substantial tax savings that can be secured from the variety of valuation discounts made possible by the FLP vehicle.
Description of the Partnership
Murphy Oil Corp was a NYSE listed company that had originated as a family-owned business. The Murphy family retained a substantial stock interest in the company. The family also had substantial holdings in a timber and banking company. Mr. Murphy established an FLP to pool and grow the family’s wealth. He created an LLC as the general partner of the FLP, taking a 49% interest for himself. He transferred $89 million in Murphy Oil stock to the FLP, along with publicly-traded stocks in a timber and banking company, and real estate holdings. When the funding was complete, Mr. Murphy owned a 95.2% limited partnership interest in the FLP.
FLP Assets Excluded from Estate
The IRS challenged the legitimacy of the FLP, alleging that the FLP assets were includable in the Murphy estate under IRC Secs. 2036(a)(1) and 2036(a)(2). After hearing from several witnesses, the court found that the FLP was created to accomplish, among other things, the following:
- Pool family assets for investment;
- Pass management responsibility to the next generation;
- Enable the father to make lifetime gifts of FLP interests;
- Protect family assets from creditors, failed marriages, and dissipation by future generations.
The court concluded that the FLP had been formed “in good faith and for legitimate and significant non-tax purposes,” that were sufficient to exclude its assets from the father’s gross estate by virtue of the bona fide sale exception.
The court also upheld substantial valuation discounts that had been applied to the decedent’s interests. The decedent’s interest in the FLP at death consisted of a 95.2% limited partner interest the FLP and a 49% interest in an LLC that owned a 2.3% general partnership interest in the FLP.
Both the estate’s and the IRS’s appraisers employed a net asset approach to valuing the FLP. In valuing the Murphy Oil stock, the estate applied a 5% blockage/Rule 144 discount to reflect, among other things, the size of the block relative to daily trading volume (blockage) and transfer restrictions (Rule 144). The court accepted this discount. The court also accepted a 5% blockage discount to the unrestricted shares of the timber company and a 12.7% discount to the timber company shares that were subject to Rule 144 restrictions. This discount was calculated by means of the Black/Scholes put option approach.
The court next applied a discount for lack of control (DLOC) to reflect the fact that FLP LP interest holders had no direct control over the assets of the FLP. This worked out to an 11% discount for the equity portion of the FLPs portfolio, 26.3% for the real estate, and 2% for the cash portion, or an average of 12.5% overall.
Finally, the appraisers considered a discount for lack of marketability (DLOM) for Mr. Murphy’s interests in the FLP. The estate’s appraiser proffered a discount of 32.5%, versus a discount of 12.5% put forward by the IRS. The court adopted the estate’s 32.5%.
The Bottom Line
The overall seriatim discounts in this case worked out to 41% from net asset value for the estate’s LP interest and 52% for the LLC interest.
After applying all of the various discounts, the court found the fair market value of the Murphy estate FLP interest to be $74.5 million, (versus $106.24 asserted by the IRS). The court ordered a complete tax refund.