TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, November 26, 2004

Jensen on Family Limited Partnerships

Pittsburgh_tax_review_1Ronald Jensen (Pace) has published The Magic of Disappearing Wealth Revisited: Using Family Limited Partnerships to Reduce Estate and Gift Tax, 1 Pitt. Tax Rev. 155 (2004). Here is part of the abstract:

A "family limited partnership" is a popular device designed to minimize, or even eliminate, gift and estate tax. Typically, a taxpayer will transfer his or her business (or possibly liquid assets) to a limited partnership in exchange for a general partnership interest representing a minute part of the partnership’s equity (say 1%) and limited partnership interests representing the bulk of the equity (say 99%). The taxpayer then gives the limited partnership interests to his beneficiaries, generally over a period of years, taking full advantage of the annual exclusion and the unified gift tax credit. The limited partnership interests are valued at a deep discount from the value of the underlying assets they represent on the ground that such interests lack control and are difficult to market. Courts have generally allowed discounts of from 25 to 35%, and in some cases, even more. IIn this manner, a taxpayer can transfer the bulk of his estate to his beneficiaries at little or no transfer tax.

In this article, Professor Jensen concludes that the discounts allowed by the courts are proper under existing valuation principles. He argues, however, that these principles frequently undervalue the true worth of a limited partnership interest, because they artificially treat the donee of such an interest as an “outsider” and thus ignore many elements of value that exist when a business is owned by a family....

On the other hand, the proposals for reform, such as the attribution and aggregation approaches that are described in the article, succumb to the opposite fallacy: they assume complete solidarity and unanimity among the different the family members. Drawing on the extensive literature on family businesses, the article demonstrates that in many cases, the fact that a business is a “family” business exacerbates, rather than ameliorates, the inevitable disputes that arise in a business. In such cases, unresolved emotional issues that even the family members themselves may not recognize intensify the business dispute. The family member who holds a minority interest in these cases will be treated no better, and possibly even worse, than an “outsider.” Such family squabbles occur most often between a parent and a child and between siblings.

To avoid the weaknesses of both the current law and the attribution or aggregation approach, Professor Jensen proposes an intermediate solution that would disallow discounts for lack of control and lack of marketability where a family limited partnership is formed for the “principal purpose” of qualifying gratuitous transfers for such discounts....

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Is it strange that gifts of fractional interests in property (even to related parties) enjoy valuation discounts whereas such discounts are not available under the estate tax rules? Sometimes the sum of the parts is much less than the whole.

Posted by: Shag from Brookline | Nov 27, 2004 4:01:50 AM