Thursday, June 05, 2008

Holman v. Commissioner

On June 3, 2008, Steve R. Akers, Associate Fiduciary Counsel, Bessemer Trust, Dallas, Texas, circulated by email the summary of his article entitled "Holman v. Commissioner: Tax Court Rejects Indirect Gift Theory For Gifts of Partnership Interests Soon After an FLP is Formed and Applies Section 2703 to Transfer Restrictions", together with a link for his full analysis.

Following is a summary of the opinion of the U.S. Tax Court in the case Holman v. Commissioner, 130 T.C. No. 12 (PDF, 72 pages), issued on May 27, 2008. A link to his more extensive analysis is included at the end of his article.

Significance. This very important full Tax Court case addresses the IRS argument that gifts of limited partnership interests made soon after (and in some audits, months after) the formation and funding of a family limited partnership are treated as indirect gifts of the partnership assets (without a discount) under an “integrated transaction” theory. Planners have been awaiting the outcome of this case for almost two and a half years after the trial in December, 2005. Despite the long period of time that it has taken the Tax Court judges to come to agreement on this opinion, surprisingly there are no dissents.

Facts. The FLP contains Dell stock as its only asset. A large gift of limited partnership interests was made six days after the FLP was formed, and subsequent annual exclusion gifts were made two months and 15 months later. The IRS argued that the gift of limited partnership interests that was made six days after the partnership was formed should be treated as an indirect gift of the partnership assets, without any discount, under a step transaction or “integrated transaction” theory.

Rejection of “Integrated Transaction” Theory. The full Tax Court opinion rejects application of the step transaction/ integrated transaction approach in this situation. The court reasoned that the formation/funding of the partnership and the subsequent gifts of limited partnership interests had separate independent significance where there was a “real economic risk of a change in the value” of the partnership during the intervening six-day period. (The court suggested that its result might be different in the case of another type of investment, such as preferred stock or a long-term government bond.)

Transfer Restrictions Ignored under §2703. In addition, the court held that transfer restrictions in the partnership agreement should be ignored under section 2703 for purposes of valuing the transferred shares. Somewhat surprisingly, the court said that the “bona fide business arrangement” test and the “device” test were not satisfied, with reasoning that would apply to many transfer restrictions in FLPs containing investment assets (and seemingly also to many buy-sell agreements for closely held businesses where there are family member owners). (However, it appears that ignoring the transfer restrictions had a very small impact on the valuation of the limited partnership interests.)

Discounts of 22.4%, 25% and 16.25%. The court valued the limited partnership interests for this partnership containing only Dell stock with overall lack of control and lack of marketability discounts of 22.4%, 25%, and 16.25% for transfers in 1999, 2000, and 2001 respectively.
You can access Steve's more extensive analysis (PDF, 15 pages) of the Holman decision, online here.