Another FLP Fact Pattern: Holman v. Commissioner
In Holman v. Commissioner, the latest family limited partnership (FLP) case to go before the Tax Court, victories were had on behalf of both the taxpayer and the IRS. After all was said and done, the Tax Court increased the value of the taxpayer's gifts of FLP units to his children because the FLP's restrictions on the transferability of the children's interests did not serve a "bona fide business purpose" (victory for the IRS), but at the same time the Tax Court rejected the IRS' argument that the lack of control and marketability discounts should not have applied to the gifts. This resulted in a substantially lower value for the gifts than the IRS had originally calculated (victory for the taxpayer).
The factual scenario of Holman is relatively straightforward. The taxpayer had acquired a significant amount of Dell stock throughout his term of employment with the company. After consulting with an estate planning attorney, the taxpayer created a FLP and immediately funded it with Dell stock. After just six days had elapsed since the date of the funding of the FLP, the taxpayer gifted units of the FLP to trusts for the benefit of his children. In valuing the gifts, the taxpayer utilized both the lack of control and lack of marketability discounts, in addition to claiming a discount based upon transfer restrictions found in the FLP agreement which, in essence, were aimed at preventing the sale or transfer of FLP interests by the taxpayer's children. The IRS challenged the values of the gifts reported on the Form 709 gift tax return, making a two-fold argument.
First, pursuant to Reg. Section 25.2511-1(h)(1) the IRS argued that the transfer of the Dell stock by the taxpayer to the FLP for less than adequate consideration constituted a gift by the taxpayer as a shareholder of the FLP to the other shareholders of the FLP, to the extent of each shareholder's individual interest.
The Tax Court rejected this argument, distinguishing past cases where the argument had been successfully applied (Shepherd v. Commissioner and Senda v. Commissioner) as having involved situations where the FLP's shareholders either acquired their interests in the FLP before the transfer of property to the FLP, or instantaneously with the transfer. In Holman, the transfer of property occurred before, not after, the taxpayer transferred interests in the FLP to his children.
Second, pursuant to the "step transaction doctrine" the IRS argued that because of the short period of time that had elapsed between funding the FLP and gifting the FLP units, the separate steps of creating the FLP, funding it, and gifting FLP units should have instead been deemed a single transaction. This meant, argued the IRS, that the FLP units should have been treated as indirect gifts of Dell stock, rather than as direct gifts of FLP units, resulting in a loss of the use of the lack of control and marketability discounts applied by the taxpayer in valuing the gifts of the FLP units.
The Tax Court rejected the IRS's "step transaction doctrine" argument, observing that the FLP was formed and funded almost one week before the gifts were made, and that because of the delay in time between funding the FLP and gifting the FLP units, the taxpayer bore a real economic risk that the value of the FLP interests could fluctuate during that time. The fact that the period of time was only six days was not dispositive in the opinion of the Tax Court; the six day period was enough of a delay in time to qualify each step as its own independent "transaction".
But the Tax Court did not stop there. It went on to hold that while the lack of control and marketability discounts would apply to the gifts of the FLP units (although at a lower discount rate than that originally applied by the taxpayer), the discount applied by the taxpayer because of the FLP agreement's stringent control on the transfer of FLP units by the shareholders could not stand. The restriction appeared to the Tax Court to solely be an attempt by the taxpayer to discourage his children from dissipating the wealth transferred to them. It did not serve a bona fide business purpose.
