Rethinking the Valuation of Family Limited Partnerships Holding Passive Assets

Appraisers have a hard time figuring out how much to discount the value of an interest in a family limited partnership (FLP) because FLPs are different from regular business entities. Non-family members wouldn’t want to buy into an FLP, so the discount could be as high as 80%. But owners wouldn’t want to sell at such a big discount, and the IRS wouldn’t accept it either. The courts also tend to give smaller discounts for FLPs compared to other types of partnerships. Overall, the advice is to use discounts for FLPs in moderation. The issue of valuation discounts for FLPs holding passive assets was resolved in a court case almost 60 years ago. The court ruled that a family can’t claim a 50 percent discount on the value of their assets just by transferring them to a family holding corporation. This was to prevent people from avoiding gift and estate taxes. In the case of valuing family businesses for tax purposes, there has been a lot of confusion and disagreement in the courts. The rules say the value of the business should be based on what a willing buyer would pay a willing seller, but that doesn’t always work for family businesses. In some cases, the actual circumstances and the value to the family should be considered instead of just sticking to the rules. This has been shown in court cases involving family partnerships and corporations. So, even though there are rules, the courts have sometimes said it’s okay to consider the real situation when valuing family businesses for tax purposes. The IRS changed its mind about a rule that prevented discounts for owning small parts of a family business. The Tax Court made different decisions in some cases, allowing discounts for owning small parts of a family business, but not in others. The Tax Court has made decisions about whether to give discounts for minority stakes in family companies. Some cases say no discount should be given, but others have allowed it. In one case, the court said a family partnership was just for avoiding taxes and should not get discounts, even though it had real assets. The courts in Strangi case decided that the partnership interests should be valued based on a hypothetical market price, even though the IRS appraisal included discounts. This decision goes against past practices where certain assets are valued at their intrinsic value rather than market price. In the case of family trusts, intrinsic value is used to determine fair market value. This is because using a hypothetical market price with discounts can be unfair to the beneficiaries. Basically, when it comes to taxes and valuing assets, trusts and family businesses are treated differently. Trusts are seen as just a way to concentrate wealth, so they don’t get tax breaks and discounts on their value. But family businesses do get those benefits because they’re seen as more important for the economy. Even if a trust is set up to hold a family business, it still won’t get the same tax breaks as if the family owned the business directly. Basically, when valuing a trust, the court says that you can’t give a discount just because someone owns a small part of it. This is because the trustee has a duty to act in the best interests of all the beneficiaries, so everyone’s interests should be valued the same. So, even if someone only owns a small part of the trust, they can’t get a discount on the value of their share. The court said that a minority discount was not allowed because the trustees had to act in the best interest of the trust beneficiaries. This means that if the trustees didn’t sell the assets at a fair price, the beneficiaries could sue to make them do it. The court also said that a marketability discount wouldn’t be allowed for certain trusts holding things like real estate or publicly traded securities. In another case, the court said that no minority discount should be applied because of the trust relationship. FLPs are similar to trusts when they are used as part of a trust arrangement to help reduce the value of gifts for estate or gift tax purposes. The IRS treats FLPs holding passive, liquid assets in a similar way to trusts when it comes to valuing them. Essentially, the FLP is considered to be like a trust, and the interests that the partners have in the FLP are similar to the interests that beneficiaries have in a trust. When someone gives property to a trust, the value of the gift is the value of the assets transferred to the trust. This is the same whether the trust is revocable or irrevocable. The courts use a specific method to determine the value of partnership interests, but it may not be appropriate for trusts with passive assets. The argument is that the same method should be used for valuing transfers for both partnerships and trusts because they are similar in some ways. This argument needs a detailed record of the transaction and the roles of each person involved. Valuation theories for Family Limited Partnerships (FLPs) are still being worked out by the courts. The IRS may use a trust analogy argument to determine fair market value of passive assets in FLPs, which are assets like real estate and stocks. This argument has not been fully decided on by the courts yet. Discount rates for FLPs may also be up for debate. So, we’ll have to wait for more court decisions to know for sure. This is a collection of information and references for understanding tax court perspectives on business valuation. It includes comments from Judge Laro at a business valuation conference, references to court cases, tax regulations, and legal publications. It also discusses the concept of minority discounts and their application in estate and gift taxation. An attorney named George F. Del Duca wrote an article about estate tax laws. He used to work for the IRS and has a lot of experience in tax law. The opinions in the article are his own and not the official position of the IRS. The article was submitted by the Tax Section, which is part of The Florida Bar. The Tax Section’s goal is to teach its members about duty and service to the public, improve how the law is administered, and advance the study of law.

Source: https://www.floridabar.org/the-florida-bar-journal/rethinking-the-valuation-of-family-limited-partnerships-holding-passive-assets/