SC Lawyer, March 2004, #8. Taxation of family limited partnerships: breaking the fall.

• Author: By Robert F. August

South Carolina Lawyer

2004.

SC Lawyer, March 2004, #8.

Taxation of family limited partnerships: breaking the fall

South Carolina LawyerMarch 2004Taxation of family limited partnerships: breaking the fallBy Robert F. AugustIn the combined cases of Estate of Eugene E. Stone III v. CIR and Estate of Allene W. Stone v. CIR, TC Memo 2003-309 (Chiechi, J.), the U.S. Tax Court held that the Internal Revenue Service (Government) was required to respect five family limited partnerships (Stone LPs) established by the decedents in determining the federal estate tax liability of the estates. The government asserted estate tax deficiencies against the estates of more than $4,000,000 on the theory that the value of assets owned by the partnerships, rather than the value of the decedents' interests in the partnerships, was the proper basis for determining estate tax. The tax court has previously held in the government's favor on this theory in a series of cases beginning in 1997. The Stone case is the first taxpayer victory in this area in the tax court and reaffirms that family limited partnerships can be viable and effective estate planning tools.

The background

Beginning in the early 1990s, family limited partnerships became popular and widely-used estate planning vehicles. Because federal estate taxes are imposed upon the fair market value of a decedent's assets as of the date of death, many taxpayers began to use family limited partnerships to reduce the value of their estates. Rather than continuing to own assets outright, taxpayers would contribute assets to limited partnerships in which family members were partners. Upon the death of a family member, the estate would include partnership interests rather than the assets themselves. Because the partnership agreements would typically contain significant restrictions on the transfer of partnership interests and limitations on the ability of limited partners to participate in management, business valuation experts would apply substantial valuation discounts in valuing the partnership interests.

For example, in the Stone case, the taxpayers' valuation experts found that an average 43 percent valuation discount should be applied to the Stone LP interests included in the estates. If a 43 percent discount were applied to a limited partnership interest representing partnership assets with a value of $20,000,000, then the value of the assets subject to estate tax would be $11,400,000 ($20,000,000 x .57). Assuming the estate was in the top estate tax bracket (currently 50 percent), the amount of estate tax savings resulting from the use of a family limited partnership would be equal to 50 percent of the difference between $20,000,000 and $11,400,000, or $4,300,000.

The tax court's prior decisions

In a series of cases beginning in 1997, the tax court had ruled that the assets owned by family limited partnerships in which the decedent held an interest were includable in the estate of the decedent under § 2036 (a)(1) of the Internal Revenue Code of 1986, as amended, (Code). Section 2036(a)(1) provides as follows:

(a) General rule.

The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate...