Discounting FLP interests.

• Author: Schlueter, Joseph F.
• Position: Family limited partnerships

Early in 2003, the Service received significant victories in its ongoing battle against the use of a family limited partnership (FLP) as a strategy for gifting family assets at a discount, During the past six years, the Service has tried to attack the strategy in various ways, with little success; see, e.g., Kerr, 113 TC 449 (1999); Knight, 115 TC 506 (2000), and Est. of Jones, 116 TC 121 (2001). However, the IRS did succeed in cases presenting particularly egregious facts; see, e.g., Est. of Schauerhamer, TC Memo 1997-242; Est. of Reichardt, 114TC 144 (2000); and Est. of Harper, TC Memo 2002-121.

The tide began to turn in the Service's favor in early 2003, in Est. of Strangi, 115 TC 478 (2000), aff'd in part and rev'd and rem'd in part, 297 F3d 279 (5th Cir. 2002), on remand, TC Memo 2003-145, and Kimbell, Sr., 244 FSupp2d 700 (ND TX, 2003).These two cases solidified Sec. 2036(a) as the IRS's weapon of choice--perhaps its only weapon--in its quest to vanquish FLP discounting (although Strangi, in particular, raises significant questions as to the proper application of Sec. 2036(a)(2) in this context).

Although the Service has been successful with its use of Sec. 2036, that provision is applicable only when valuing an estate; if the donor is alive, it does not apply. For living taxpayers seeking to use FLPs for discounted gifting, two recent Tax Court cases presented situations in which the court valued discounts to be applied to transferred limited partnership interests.

Lappo

In Lappo, TC Memo 2003-258, a taxpayer contributed marketable securities and real estate to a limited partnership, then gave limited partner interests representing 98.7% of the outstanding units to her daughter and a variety of trusts for her grandchildren. She claimed approximately 54% minority-interest (MI) and lack-of-marketability (LOM) discounts on the transferred interests.

The only issue before the Tax Court was the valuation discount. Footnote 1 in the opinion states that the IRS's original deficiency notice had also presented economic substance, Sec. 2703(a)(2) restriction and taxable-gift-on-partnership-formation arguments; all of those were subsequently withdrawn. In other words, the Service retired a number of weapons it used in various 1990s rulings (see, e.g., Letter Rulings (TAMs) 9719006, 9723009, 9725002, 9730004, 9735003 and 9736004), all of which proved relatively useless. This leaves the Service only two forms of ammunition: (1) Sec. 2036(a) (for...