Holman on FLP discounts: Did the better expert win?

BVWireIssue #69-1
June 4, 2008

Last week the Tax Court issued Holman v. Commissioner (May 27, 2008), a decision jam-packed with issues relevant to gifts of family limited partnership interests, including 1) whether the transfer of assets (shares of Dell stock) constituted a direct or indirect gift; 2) whether the limited partnership should be treated (and valued) analogous to a trust; and 3) what discounts for lack of control and marketability apply to the gifts.  Of particular interest to appraisers and attorneys: Holman is a fully reviewed opinion, binding on the entire Tax Court bench.  Coming on the heels of Astleford v. Commissioner (see BVWire # 68-1), it’s another great case—“great from a guidance perspective,” says Mel Abraham in his latest e-alert.  (Go to valuationeducation.com, click on the Latest E-Alert, current issue, for his full analysis.)

In its consideration of direct/indirect gifts, Holman resurrects Chapter 14 (§§ 2703, 2704 I.R.C.), “something we haven’t seen in a long time,” Abraham says.  The valuation issues saw both experts starting with the net asset values, and both used closed-end funds to determine minority discounts.  But while the taxpayer’s expert included specialized equity funds, the IRS expert relied solely on general equity funds—which the court found the more “thoughtful” approach.  As for determining the discount for lack of marketability (DLOM), both experts began with the restricted stock studies.  But in what promises to be the most controversial aspect of the opinion, the IRS broke down the data by market access (liquidity) and holding periods, concluding that in this case, limited market access supported a 12.5% DLOM.  The IRS expert made no adjustment for a holding period, because the partnership’s redemption provisions allowed it to repurchase the shares at fair market value, thus succeeding to the benefits of any discounts.  The court agreed with this approach, finding the holding period of “little influence” in this case.

Experts weigh in.  “I am not sure I agree with that," Abraham says.  “The holding period does have an impact on the ability to liquidate [the partnership]. The uncertainty of the process gives rise to some level of discounts.”   The “metric of marketability” assumes that there is a market in place to begin with, he says—but for many of these interests (limited partnerships and minority shares in a private company), there is no ability to sell or get at cash flows.  The holding period in the restricted stock studies doesn’t change the liquidity of these interests—“it just changes the liquidity of the restricted stocks that have a publicly traded…component.”

Lance Hall (FMV Opinions) agrees that the court took a “novel interpretation of the restricted stock data.”   Its acceptance of the IRS’s proposed restructuring liquidation also “seems to depart from the fair market value ‘hypothetical willing buyer/ willing seller’ construct,” he says, in his FMV Valuation Alert™.  (Even the court noted that such a transaction “is perhaps inconsistent with the stated purpose of the partnership.”)  But primarily, Hall disagrees with the court’s determination of DLOM.  “Marketability is not an on and off switch,” he says.  The issue is one of varying degrees of liquidity.  “Rule 144A did not create a market for restricted stock…[it] merely increased the number of potential buyers, thus increasing the liquidity of restricted stock.”   Moreover, after a relatively brief holding period, restricted stock can be sold in the public marketplace at no discount—but there is no such option available for these FLP interests.  “All things being equal,” Hall says, “the restricted stock of a public company is more liquid than private stock.  It always is and always will be.  Surprisingly, the Holman Court found otherwise.”

The court’s acceptance of the liquidation premise “appears to be inappropriate,” says Owen Fiore (Kooskia, ID).  He’s also troubled by the Tax Court finding one appraiser less helpful then the other—and assigning the latter’s work greater credibility.  “Legal practitioners and their clients must work with appraisers to make certain that the valuation evidence, data used and conclusions reached are most appropriate and reasonable,” Fiore says.  “Choose your expert wisely,” Hall agrees.  “Even with its [unsupported] claims…the IRS won because it simply had the better expert.”  The abstract Holman will appear in the next (July 2008) issue of Business Valuation Update; a copy of the full-text court opinion is available to subscribers of BVLaw™.

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