The U.S. Court of Appeals for the Eighth Circuit has affirmed a decision of the U.S. Tax Court in sharply reducing valuation discounts claimed by a married couple with respect to the transfer of limited partnership (LP) interests gifted to their daughters. Holman v. Commissioner (8th Cir. 4/7/2010), 2010-1 USTC ¶60,592, aff'g 130 TC 170. The 8th Circuit agreed with the Tax Court's holding that, in calculating the value of the gifted LP interests, only small discounts were allowable for lack of control and lack of marketability, even though the limited partnership agreement contained significant limitations on the power of the limited partners to manage the LP or to transfer their interests, including a restrictive buy-sell provision permitting the general partners (parents) to redistribute LP interests if an impermissible transfer were to be made.
Taxpayers, Thomas H. Holman, Jr. and Kim Holman, owned a large number of shares of common stock in Dell, Inc., a publicly traded corporation ("Dell"), this as a result of Tom's having been an employee of Dell for many years. Tom and Kim created an LP and funded it with Dell stock. Thereafter, in 1999, 2000 and 2001, the couple gifted minority interests in the LP to their daughters, as limited partners, retaining management control over the entity as general partners.
In filing their gift tax returns for the years in question, the couple discounted the value of the transferred LP interests by 49%, claiming lack-of-marketability and minority-interest adjustments based on the restrictive provisions set forth in the LP agreement, including the transfer restriction, and asserting that such restrictions would depress the value of the LP interests relative to the value of the underlying assets of the LP, the Dell stock. In doing so, taxpayers claimed a value for the gifted interests which was substantially below the market value of the underlying Dell stock.
On audit, IRS challenged taxpayers' gift tax returns for the years in question. IRS characterized the intrafamily transfers as gifts of Dell stock rather than as gifts of LP interests, and disregarded the LP agreement's transfer restrictions for valuation purposes based on §2703 of the Internal Revenue Code. IRS conceded that lack-of-marketability and minority-interest discounts were applicable, but argued that the overall discount should be much smaller than that claimed by taxpayers: 28% relative to the then-prevailing market price of Dell stock.
TAX COURT DECISION
The Tax Court held that the gifts were indeed gifts of LP interests, not of Dell stock, and that IRS had correctly applied Tax Code §2703 in disregarding the LP agreement's transfer restrictions. However, the Tax Court applied much smaller lack-of-marketability and minority-interest discounts than those claimed by taxpayers, noting that the LP held only highly liquid, easy-to-value assets and that the LP agreement contained a consensual dissolution provision. As a result, the Tax Court accepted lack-of-marketability valuation discounts for each of the years in question of just 12.5%, and minority-interest valuation discounts of just 4.63% to 14.34% (i.e., discounts that were even lower than those proposed by IRS). Taxpayers' stated purposes in creating the structure, to wit, estate planning, tax reduction, wealth transference, spendthrift protection and money management education, were held not to be bona fide business purposes for the transfer restrictions provided for in the LP agreement. The Court of Appeals took notice of the fact that the Tax Court, when it determined the appropriate discount for the LP interests, had co