Section 17 Fair Market Value and Discounts

• Library: Bus Trans 2005

In 1993, the IRS issued a Ruling that acknowledged that minority discounts could be applied when valuing an interest in a family entity. Rev. Rul. 93-12, 1993-1 C.B. 202. This Ruling provided the opportunity for estate planners to advise clients to place passive assets in a limited partnership and obtain significant reduction in the value of entity interests that are transferred.

In valuing the partnership interest that is transferred, two discounts may be applied. The minority discount reflects that the ownership interest transferred does not allow the recipient any control over the entity. In particular, the recipient of the interest does not have sufficient interest in the entity to compel liquidation and obtain a pro rata share of the underlying partnership assets. The marketability discount applies because the interest in the closely held business is not freely transferable. The amount of each discount varies, and they are often combined to allow a significant overall discount (often from 20% to as high as 60%).

The discounts are used to establish a fair market value of the limited partnership interest transferred at a value less than the proportionate value of the underlying partnership assets. The valuation discounts are available for valuing partnership interests that are transferred for gift tax purposes and also to value the limited partnership interests held at death for estate tax purposes.

Because of the growing use of family limited partnerships, the IRS has been aggressively challenging the valuation discounts being claimed on gift tax returns or estate tax returns for transfers of partnership interests. There have been many court decisions involving the valuation of partnership interests. In early 1997, the IRS began its attack on family partnerships with the issuance of several Technical Advice Memoranda. See:

• Tech. Adv. Mem. 9719006 (Jan. 14, 1997)
• Tech. Adv. Mem. 9723009 (Feb. 24, 1997)
• Tech. Adv. Mem. 9725002 (Mar. 3, 1997)
• Tech. Adv. Mem. 9730004 (Apr. 3, 1997)
• Tech. Adv. Mem. 9735003 (May 8, 1997);
• Tech. Adv. Mem. 9736004 (June 6, 1997).

In addition, in the last several years, there have been numerous cases involving valuation of limited partnership interests. See:

• Estate of Schauerhamer v. Comm’r, T.C. Memo 1997-242 (1997);
• White v. Comm’r, No. 14412-97, 1998 Tax Ct. Memo LEXIS 465 (Tax Court Jan. 12, 1998) (unreported decision);
• Estate of Nowell v. Comm’r, T.C. Memo 1999-15 (1999);
• Estate of Mellinger v. Comm’r, 112 T.C. 26 (1999);
• Kerr v. Comm’r, 113 T.C. 449 (1999);
• Church v. United States, 85 A.F.T.R.2d (RIA) 2000-804 (W.D. Tex. 2000);
• Estate of Reichardt v. Comm’r, 114 T.C. 144 (2000);
• Estate of Harper v. Comm’r, T.C. Memo 2000-202 (2000);
• Adams v. United States, 218 F.3d 383 (5^th Cir. 2000);
• Shepherd v. Comm’r, 115 T.C. 376 (2000);
• Strangi v. Comm’r, 115 T.C. 478 (2000), aff’d in part and rev’d and remanded in part, 293 F.3d 279 (5^th Cir. 2002) (Strangi I);
• Knight v. Comm’r, 115 T.C. 506 (2000);
• Jones v. Comm’r, 116 T.C. 121 (2001);
• Estate of Harper, T.C. Memo 2002-121 (2002);
• Estate of Thompson, T.C. Memo 2002-246 (2002), aff’d sub nom. 382 F.3d 367 (3^rd Cir. 2004);
• Kimbell v. United States, 244 F. Supp. 2d 700 (D.C. Tex. 2003), rev’d and remanded, 371 F.3d 257 (5^th Cir. 2004);
• Strangi v. Comm’r, T.C. Memo 2003-145 (2003) (Strangi II);
• Estate of Abraham, T.C. Memo 2004-39 (2004);
• Estate of Hillgren, T.C. Memo 2004-46 (2004);
• Senda v. Comm’r, T.C. Memo 2004-160 (2004).

In these rulings and cases, the IRS has offered several...