By: Anne R. Meltzer, CPA/ABV, ASA
The IRS is focusing on the discounts taken on limited partnership interests in family limited partnerships and limited liability companies, particularly those that hold portfolios of publicly traded securities. While there is language in the tax code that allows for discounts for lack of control and lack of marketability, the law does not specify the magnitude of the allowable discounts. This same tax code also states that the Treasury Department can add restrictions on asset discounts by adding additional “disregarded restrictions” under Section 2704. In particular, the Treasury Department would look to the restrictions in the formation documents and disregard many which place restrictions on the transfer of interests and the liquidation of interests which support the discount for lack of marketability.
This has been on the IRS’s agenda for many years and now it appears that the Treasury Department may act. According to Cathy Hughes, a tax lawyer in the Treasury Department’s Office of Tax Policy, proposed regulations could be out by the American Bar Association’s next taxation section meeting in mid-September.
By disregarding certain common restrictions in family limited partnerships, such as the right to transfer the interest or liquidate the interest, a discount for lack of marketability would be effectively decreased. Under the definition of fair market value, the transferor still needs to find a willing buyer. The “market” for fractional interests in limited partnerships and LLC’s remains severely limited, as a potential buyer can almost always create an equally desirable investment without being subject to the partnership agreement. This is especially true for partnerships owning marketable securities.
Whether by adding disregarded restrictions or directly limiting discounts, the IRS seeks to increase the value of gifts, and increase the amount of gift taxes. Valuation experts have relied on IRS Revenue Ruling 59-60 for over 50 years to define “fair market value”. So, perhaps a re-write of the definition will be in the offing, or an artificial discount will be required in order to transfer gifts in the future. If say, discounts were to be limited to 10% for tax purposes that does not change what the market thinks a discount should be – so we have a willing seller, but not a willing buyer.
Tucker & Meltzer has valued hundreds of these entities in our 10 year history. Our approach to valuing family limited partnerships and limited liability companies that hold publicly traded securities is to review empirical market data for an appropriate discount for lack of control. We look at the salient features of each entity’s organization documents, the liquidity of the underlying assets and the distribution history of the entity to determine a reasonable and supportable discount for lack of marketability.
However, if the Treasury Department increases the number of disregarded restrictions and thereby puts limits on the allowable discounts, these reasonable approaches may not be allowable in the future. In our view, the matter may take years to be hashed out in the tax courts.
The Treasury Department has indicated that the final regulations may become effective retroactively. Now would be an excellent time to consider accelerated planning and to make transfers for individuals with taxable estates, particularly if the assets are expected to appreciate. As valuation advisors we would recommend transfers to capture valuable discounts while they still exist.