8th Circuit confirms Tax Court's buy-back limits on marketability discounts

Most appraisers who do valuations for tax purposes remember Holman v. Commissioner (May 2008), in which the taxpayers gifted substantial holdings of Dell stock into a highly restricted family limited partnership (FLP). The Tax Court agreed with the IRS, finding the transfer restrictions were merely tax avoidance devices and should be disregarded for valuation purposed under IRC Sec. 2703. Further, the Tax Court adopted the IRS expert’s valuation of the FLP interests, finding the restrictive buy-back provisions placed a natural limit or “cap” on any marketability discounts. In other words, if potential buyers of a limited partner’s shares demanded too great a discount relative to the then-prevailing price of Dell stock, then the remaining partners (acting as “economically rational insiders’) would have a clear incentive to step in and buy the shares at a lesser discount.

The taxpayers appealed, arguing the Tax Court’s rationale violated the fair market value standard by asking what the FLP (or its particular family members) would do when faced with a buy-back situation. The taxpayers also contested the application of Sec. 2703, claiming the FLP’s transfer restrictions were a bona fide business arrangement, comparable to an arm’s length agreement entered into by unrelated parties.

Despite a strong dissent by a single judge, the majority of the U.S. Court of Appeals for the Eighth Circuit disagreed, confirming the Tax Court’s decision and the IRS’s use of Sec. 2703 as a weapon against FLPs, at least in the gift tax context. Read the complete case digest of Holman v. Commissioner (April 7, 2010), in the May 2010 Business Valuation Update™; the full text of the court’s opinion will also be available at BVLaw™.