For the second time in recent months, the U.S. Tax Court has considered an IRS challenge to a family limited partnership (FLP) under IRC Sec. 2511 as an indirect gift. This new case, Gross v. Commissioner (Sept. 29, 2008), comes with a few interesting twists, however. First, the IRS stipulated to a combined minority and lack of marketability discount of 35%—if the taxpayer could show that the eleven days between the founder’s transfer of funds to the FLP and the creation of limited partnership interests was not an indirect gift. The IRS must have thought its odds were good, because the partners did not execute a limited partnership agreement, creating the LP interests, until after the transfer was complete. Six months before, the FLP had complied with all other filing and notice requirements under applicable New York law, but the IRS claimed that it didn’t formally exist until execution of the agreement, thus telescoping all critical events—formation, funding, distribution of interests—into a single day.
In a last wrinkle, the same judge who heard the Gross case (Judge Halpern) also decided Holman v. Commissioner (May 2008), in which the Tax Court found that six days between funding the FLP to distribution of the LP interests was sufficient to disqualify the transfer as an indirect gift, and also take it out of the “step transaction doctrine” (treating a series of intertwined events as one). “We reach the same conclusion here,” the Gross court said, where eleven days passed between funding and formation and where (as in Holman), the assets were common shares of well-known public companies. Key to its finding: Even though the parties may not have created a limited partnership until after the asset transfer, by filing the certificate and agreeing to essential terms, they had created a general partnership. The taxpayer “won,” and the court adopted the 35% stipulated discount.
Curiously, the IRS did not raise a Sec. 2703 argument in this case, as it did in Holman—claiming the court should ignore the severe transfer restrictions that the FLP imposed on the limited partners’ interests. Given these restrictions and the substantial control that the founder/general partners retained over the assets in both cases—watch for the IRS to attack these FLPs when their founders die, attempting to bring the full undiscounted value of the LP interests back into the estate under Sec. 2036. Presumably, the Holmans and the widow Gross are still in good health—and could use the advice of a qualified business appraiser and tax advisor. Copies of both cases are available at BVLaw™, and an abstract of Gross will be in the next (November 2008) Business Valuation Update™.
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