In Estate of Streightoff (TCM 2018-178), the IRS successfully argued the 89% interest in an FLP included in the estate was a limited partner interest, and not an assignee interest. The Court looked to the characteristics of the property transferred and the admission requirements of the partnership agreement, with consideration to substance over form. Streightoff also provides an interesting view of what constitutes a controlling interest. Here, per the partnership agreement, 75 percent of limited partner interests could remove the general partner and terminate the partnership. Therefore, the interest was held to have control and the ability to liquidate. However, even though the interest had the ability to force a termination of the partnership, the IRS’ appraiser chose to apply an 18% discount for lack of marketability. This strange position (for the IRS) was essentially unopposed and the Tax Court allowed it.
Background
Streightoff Investments, LP was formed on October 1, 2008, and held cash and marketable securities. Upon formation, the partners were comprised of Mr. Streightoff (decedent) with an 89% limited partner interest and his daughters, sons, and former daughter-in-law collectively owning the remaining 10% limited partner interest. Streightoff Management, LLC owned the 1% general partner interest. Mr. Streightoff’s daughter, Elizabeth Doan Streightoff, was manager of Streightoff Management, LLC.
Mr. Streightoff died on May 6, 2011. The estate’s executor, Elizabeth Doan Streightoff, elected to use the alternate valuation date of November 6, 2011 for reporting purposes. The partnership’s assets were valued at $8,212,103 on this date.
Issues at stake involved: (1) the nature of the interest reportable on the estate tax return, and (2) the magnitude of discounts for lack of control and lack of marketability. The IRS’s appraiser valued the estate’s interest as an 89% limited partner interest. The taxpayer’s appraiser valued the estate’s interest as an 89% assignee interest. Each party applied discounts consistent with the respective interest type. Following is a summary of some of the noteworthy agreement provisions given the issues at stake.
- The partnership would terminate December 31, 2075, unless terminated sooner upon the happening of certain events
- Partners could remove the general partner by written agreement of limited partners owning 75% or more of the partnership interests held by all limited partners
- The partnership terminated upon the removal of the general partner
- If the partnership terminated by reason of the general partner’s removal, then 75% of the limited partners could reconstitute the partnership and elect a successor general partner
- A transferee of an interest in the partnership could become a substituted limited partner upon satisfaction of all of the following conditions:
- General partner consent
- A permitted transfer (family, certain related parties, or any purchaser subject to a right of first refusal)
- Executing documents as the general partner may request to confirm that the transferee agreed to be bound by the terms and conditions of the partnership agreement
Assignee Interest vs Limited Partner Interest
On the date the partnership was formed, Mr. Streightoff executed an assignment of interest transferring his 89% interest to his revocable trust which designated Mr. Streightoff as “assignor” and the revocable trust as “assignee”. The agreement stated that Mr. Streightoff transferred with the interest “all and singular the rights and appurtenances thereto in anywise belong”. Although the transfer was labeled an “assignment”, the agreement states that the revocable trust is entitled to all rights associated with the ownership of decedent’s 89% limited partner interest, not those of an assignee. The Court also notes that while state law generally determines the property interest transferred for Federal estate tax purposes, the substance of the transaction over form is also considered. In this case, the general partner gave consent to the transfer of all of decedent’s rights in the partnership to the revocable trust, the transfer was a permitted transfer, and the agreement provided that the revocable trust agreed to abide by all terms and provisions of the partnership and the trustee executed the agreement on behalf of the revocable trust. Accordingly, the Court concluded that the interest to be valued for estate tax purposes was an 89% limited partner interest.
A Look at the Discounts
Next, we’ll look at the discounts which were taken consistent with each party’s interpretation of the interest type. The estate appraiser valued the subject interest as an assignee interest, applying a 13.4% discount for lack of control and a 27.5% discount for lack of marketability (applied sequentially, a combined 37.2% discount).
The IRS appraiser valued the subject interest as a limited partner interest, applying no discount for lack of control and an 18% discount for lack of marketability. The case summarizes that the IRS appraiser considers that due to the provisions of the agreement, a holder of an 89% limited partner interest has the ability to unilaterally terminate the partnership if he or she does not agree with the management of the general partner. In citing this factor, the IRS appraiser concludes at no discount for lack of control but concludes at an 18% discount for lack of marketability using restricted stock studies. Since the estate’s appraiser valued (in the eyes of the Court) the wrong thing, the Tax Court accepts the IRS’s discount analyses as-is.
Practice Tips
Regardless of the assignment labeling the trust as “assignee”, substance over form and the transferee meeting the limited partner admission conditions of the agreement prevailed even if the partnership did not hold meetings or have votes. That issue aside, a reading of the Tax Court memorandum suggests the taxpayer lucked out here: how does the estate get an 18% discount for lack of marketability on an 89% interest that has the ability to unilaterally terminate the partnership?[1] This seems extraordinarily generous given that terminating the partnership (which held mostly marketable and easily salable securities) would also provide liquidity upon termination with the sale of partnership assets or an in-kind distribution.
[1] Alternatively, perhaps there was an IRC 2704(b) consideration made here? This is mere speculation on my part as this is not discussed in the Court’s opinion (but perhaps was in the IRS appraiser’s report) However, since this was a family-controlled entity perhaps dissolution and liquidation provisions of the agreement contrary to state law for Texas limited partnerships may have been disregarded by the IRS appraiser in determining the DLOM. This is the only way we can easily understand how an 18% discount for lack of marketability was applied to an interest that had control and the ability to achieve liquidity in relatively short order.