Estate of Frank D. Streightoff, Elizabeth Doan Streightoff v. Commissioner , 2018 T.C. Memo. 178 ( 2018 )

T.C. Memo. 2018-178
UNITED STATES TAX COURT
ESTATE OF FRANK D. STREIGHTOFF, DECEASED, ELIZABETH DOAN
STREIGHTOFF, EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4379-15. Filed October 24, 2018.
Michael C. Riddle and Harold A. Chamberlain, for petitioner.
Susan M. Fenner and Christina D. White, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KERRIGAN, Judge: Respondent determined a deficiency of $491,750 in
the Federal estate tax of the Estate of Frank D. Streightoff (estate). The issue for
consideration is the type and value of an interest that Frank D. Streightoff
(decedent) transferred during his lifetime to a revocable trust. Unless otherwise
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[*2] indicated, all section references are to the Internal Revenue Code in effect for
the date of decedent’s death, and all Rule references are to the Tax Court Rules of
Practice and Procedure. We round all monetary amounts to the nearest dollar.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated facts are
incorporated in our findings by this reference. Decedent died May 6, 2011. He
resided in Texas at the time of his death. Decedent’s daughter, Elizabeth Doan
Streightoff (Ms. Streightoff), was appointed executor of the estate. She resided in
Texas when the petition was filed. During decedent’s lifetime Ms. Streightoff also
held decedent’s power of attorney (POA). The estate was probated in Texas.
I. Streightoff Investments, LP
On October 1, 2008, decedent, through Ms. Streightoff, formed Streightoff
Investments, LP (Streightoff Investments), as a limited partnership under the
provisions of the Texas Revised Limited Partnership Act (TRLPA), Tex. Rev. Civ.
Stat. Ann. art. 6132a-1 (West 2008). Streightoff Investments did not hold
partnership meetings or have votes.
The partnership agreement stated that the purpose of Streightoff
Investments was to make a profit, increase wealth, and provide a means for
decedent’s family to manage and preserve family assets. Decedent funded
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[*3] Streightoff Investments with assets including marketable equity securities,
municipal bonds, mutual fund investments, other investments, and cash. As of
January 31, 2009, 61.6% of Streightoff Investments’ assets consisted of
marketable equity securities, 23.6% consisted of fixed-income investments in
municipal bonds, and 13.3% was invested in mutual funds. Its portfolio of
publicly traded marketable equity securities was managed by professional money
managers. The remaining 1.5% was invested in cash and other investments.
Streightoff Management, LLC (Streightoff Management), was Streightoff
Investments’ sole general partner. Ms. Streightoff was manager of Streightoff
Management. The partnership agreement for Streightoff Investments provided
that the general partner “shall perform or cause to be performed * * * the trade or
business of the Partnership”, subject only to limitations set forth expressly in the
partnership agreement.
Decedent, his daughters, his sons, and his former daughter-in-law were
Streightoff Investments’ original limited partners under the partnership agreement.
The limited partners other than decedent received their limited partnership
interests as gifts. Decedent reported these gifts on a Form 709, United States Gift
(and Generation-Skipping Transfer) Tax Return, filed for 2009.
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[*4] The partnership agreement specified that decedent and the other partners
received the following interests upon formation:
Percentage
Partner General or limited interest
Streightoff Management General 1.00%
Decedent Limited 88.99
Elizabeth Streightoff Limited 1.54
Ann Fennell Brace Limited 1.54
Camille Schuman Limited 1.54
Jennifer Ketchum Hodges Limited 1.54
Hilary Dane Billingslea Limited 1.54
Charles Franklin Streightoff Limited 0.77
Frank Hatch Streightoff Limited 0.77
Priscilla Streightoff Limited 0.77
Section 1.5 of the partnership agreement provided that Streightoff
Investments would terminate December 31, 2075, unless terminated sooner upon
the happening of certain events. Section 1.5(b) provided that the partnership
terminated upon the removal of the general partner. Under article V limited
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.
Section 1.5 provided that if the partnership terminated by reason of the general
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[*5] partner’s removal, then 75% of the limited partners could reconstitute the
partnership and elect a successor general partner. Limited partners owning at least
75% of the ownership percentage in the partnership could approve the admission
of additional limited partners to the partnership.
Section 7.2 of the partnership agreement provided that a limited partner
could not sell or assign an interest in Streightoff Investments without obtaining the
written approval of the general partner, which the agreement provided would not
be unreasonably withheld. Pursuant to section 7.2 any partner who assigned his or
her interest remained liable to the partnership for promised contributions or
excessive distributions unless and until the assignee was admitted as a substituted
limited partner. Once the assignee was admitted as a substituted limited partner,
the assignor no longer was liable to the partnership. The general partner could
elect to treat an assignee as a substituted limited partner in the place of the
assignor. An assignor was deemed to continue to hold the assigned interest for the
purposes of any vote taken by limited partners under the partnership agreement
until the assignee was admitted as a substituted limited partner.
All transfers of interests in Streightoff Investments were subject to
limitations. Section 9.2 provided that partners in the partnership were allowed to
make only permitted transfers of their interests. Permitted transfers were transfers
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[*6] (1) to any member of the transferor’s family, (2) to the transferor’s executor,
trustee, or personal representative to whom his or her interest passes at death or by
operation of law, or (3) to any purchaser, but subject to the right of first refusal
held by the persons listed in section 9.4.
Section 9.4 provided that any partner who received an outside purchase
offer for his or her interest was required, before accepting the offer, to provide
each of the “priority family”,1 the partnership, and the general partner an
opportunity to acquire the interest according to terms the same as or better than
those offered by the outside purchaser. Whether the partnership exercised its right
of first refusal to purchase a partner’s interest was subject to the approval of the
general partner and limited partners owning at least 50% of the partnership
interests held by all limited partners (with the exception of the seller if he or she
was a limited partner).
The partnership agreement referred to persons who acquired interests in
Streightoff Investments but who were not admitted as substituted limited partners
to the partnership as “unadmitted assignees”. Section 9.6 provided that
“unadmitted assignees” were entitled only to allocations and distributions in
1
The partnership agreement defines priority family as the transferor’s
“spouse, natural or adoptive lineal ancestors or descendants, and trusts for his or
their exclusive benefit.”
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[*7] respect of their acquired interests. “Unadmitted assignees” had no right to
any information or accounting of the affairs of the partnership, were not entitled to
inspect the books or records of the partnership, and did not have any of the rights
of a general or limited partner under TRLPA.
The partnership agreement provided that a transferee of an interest in
Streightoff Investments could become a substituted limited partner upon
satisfaction of certain conditions set out in section 9.7. These conditions included:
(1) that each general partner consent; (2) that the interest with respect to which the
transferee is being admitted be acquired by means of a permitted transfer;
and (3) that the transferee become a party to the partnership agreement as a limited
partner and execute such documents and instruments as the general partner may
request to confirm that the transferee agreed to be bound by the terms and
conditions of the partnership agreement. The partnership agreement provided that
an interest holder who was admitted to the partnership as a substituted limited
partner would be treated the same as an original limited partner under the terms of
the partnership agreement.
II. Frank D. Streightoff Revocable Living Trust
On October 1, 2008, the same day that decedent formed Streightoff
Investments, he established the Frank D. Streightoff Revocable Living Trust
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[*8] (revocable trust). Also on October 1, 2008, he transferred his 88.99% interest
in Streightoff Investments to the revocable trust. Decedent was grantor of the
revocable trust, and he held the power during his life to amend, alter, revoke, or
terminate it. He was the revocable trust’s sole beneficiary, and Ms. Streightoff
was the trustee. Decedent was entitled to receive distributions of trust income and
could receive distributions of the trust principal upon his request.
On October 1, 2008, decedent, through Ms. Streightoff, executed an
agreement entitled “Assignment of Interest” (agreement), which designated
decedent as “assignor” and the revocable trust as “assignee”. The agreement
provided that decedent made an “assignment” of all of his limited partnership
interest in Streightoff Investments. It provided that decedent transferred “[his]
interest in the above described premises, together with all and singular the rights
and appurtenances thereto in anywise belonging, unto the said Assignee, its
beneficiaries and assigns forever” and that he bound himself and “[his] heirs,
executors, and administrators to * * * provide any further documentation or
execute any additional legal instruments necessary to provide the assignee all the
rights the Assignor may have had in the property.” The agreement provided that
the revocable trust “by signing this Assignment of Interest, hereby agrees to abide
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[*9] by all the terms and provisions in that certain Limited Partnership Agreement
of STREIGHTOFF INVESTMENTS, LP, dated effective October 1, 2008.”
Decedent’s transfer of his interest was a permitted transfer under section 9.2
of the partnership agreement. Ms. Streightoff signed the transfer agreement in her
capacities as holder of decedent’s POA, trustee of the revocable trust, and
managing member of Streightoff Management.
III. Estate Tax Return and Notice of Deficiency
On August 9, 2012, the estate filed a Form 706, United States Estate (and
Generation-Skipping Transfer) Tax Return (estate tax return). Ms. Streightoff as
decedent’s executor elected to use the alternate valuation date of November 6,
2011, to value the estate’s assets. On the estate tax return the estate reported a
gross estate less the exclusion of $5,051,299.
On November 6, 2011, the partnership’s net asset value (NAV) was
$8,212,103. It held the following assets with the following market values:
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[*10] Assets Market value
Cash $198,453
Marketable equity securities 5,590,778
Marketable municipal bonds 2,386,277
Marketable corporate bonds 30,366
Sovereign debt 6,229
Total 8,212,103
The estate reported on the estate tax return that decedent had made transfers
described in section 2035, 2036, 2037, or 2038 during his lifetime. It filed with
the estate tax return a Schedule G, Transfers During Decedent’s Life, identifying
those transfers. A supplemental statement attached to the estate tax return
provided the following explanation with respect to decedent’s lifetime transfers:
THE DECEDENT ESTABLISHED * * * [the revocable trust], FOR
WHICH THE TERMS WERE REVOCABLE AND AMENDABLE
BY THE DECEDENT DURING HIS LIFETIME. THE VALUE OF
THE ASSETS TRANSFERRED TO THE TRUSTEE DURING THE
LIFETIME OF THE DECEDENT HAVE BEEN REPORTED,
PURSUANT TO SECTION 2038 OF THE INTERNAL REVENUE
CODE, ON SCHEDULE G * * *.
On Schedule G the estate described the property transferred to the revocable
trust as an assignee interest in an 88.99% limited partnership interest. The estate
reported the value of the transferred interest as $4,588,000 as of the alternate
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[*11] valuation date. The estate’s valuation of the transferred interest calculated
88.99% of the partnership’s NAV on the alternate valuation date (i.e., $7,307,951)
and discounted that value by 37.2%. In a supplemental statement the estate
indicated that it claimed discounts for lack of marketability, lack of control, and
lack of liquidity.
On January 9, 2015, respondent sent the notice of deficiency on which this
case is based (notice), determining a deficiency of $491,750. The notice contained
a letter addressed to the estate’s representative and its counsel, Michael C. Riddle,
with several enclosures. The enclosures included a Form 1273, Report of Estate
Tax Examination Changes, a Form 6180, Line Adjustment--Estate Tax, and two
Forms 886-A, Explanation of Items. The Form 6180 showed an adjustment in
value to items reported on Schedule G of $1,405,000. The attached Forms 886-A
stated respondent’s determination that the corrected value of decedent’s interest in
Streightoff Investments on the alternate valuation date was $5,993,000.
IV. Procedural Backround
On June 19, 2015, the estate filed a motion for summary judgment
contending that in issuing the notice respondent had violated provisions of the
Administrative Procedure Act (APA). On September 13, 2016, a hearing was held
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[*12] on the motion. The estate argued that the notice was invalid and should be
set aside and that the Court lacked jurisdiction.
On September 15, 2016, the Court rendered an Oral Findings of Fact and
Opinion on the estate’s motion. We rejected the estate’s contentions regarding the
validity of the notice and held that the Court had jurisdiction to redetermine the
deficiency at issue. We concluded that “the application of APA to proceedings for
the redetermination of a deficiency, such as this one, have been soundly rejected in
Ax v. Commissioner, 146 T.C. __ (April 11, 2016).” On October 11, 2016, the
Court issued an order denying the motion for summary judgment.
OPINION
I. Validity of the Notice
The estate contends that the notice states a naked deficiency amount
because it describes no basis for the determination of any additional tax due. It
argues that respondent valued a property interest that decedent did not own on his
date of death. Respondent contends that the notice is valid and does not violate
section 7522(a).
Section 7522(a) provides that any deficiency notice “shall describe the basis
for * * * the tax due * * * in such notice.” An inadequate description of the basis
for the deficiency does not invalidate the notice. Id. Generally, we have required
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[*13] that a notice provide a formal notification that a deficiency in tax has been
determined. Pietz v. Commissioner, 59 T.C. 207, 213-214 (1972). We look at the
notice with all the attachments as a whole. See Saint Paul Bottling Co. v.
Commissioner, 34 T.C. 1137, 1138 (1960).
The notice states the year and the amount of estate tax due. Attached to the
notice were Forms 886-A, which showed respondent’s determination of the value
of decedent’s interest in Streightoff Investments. We conclude on the evidence
that respondent complied with section 7522(a). Even if we concluded that
respondent had not provided the basis for the determination, the case would not be
dismissed, because an inadequate description does not invalidate a notice of
deficiency. See sec. 7522(a)
II. Burden of Proof
Generally, the taxpayer bears the burden of proving that the Commissioner’s
determinations in the notice of deficiency are erroneous. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift to the
Commissioner if the taxpayer establishes that it complied with the requirements of
section 7491(a)(2)(A) and (B) to substantiate items, to maintain required records,
and to cooperate fully with the Commissioner’s reasonable requests. The estate
contends that the burden of proof should be shifted to respondent.
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[*14] We conclude that the parties have stipulated all operative facts and
documents needed to decide the issues presented, and which party bears the
burden of proof is irrelevant. Estate of Morgens v. Commissioner, 133 T.C. 402,
409 (2009), aff’d, 678 F.3d 769 (9th Cir. 2012). The nature of the property
interest transferred to the revocable trust is a legal issue that can be decided on the
basis of the agreed facts.
The question of fair market value is an question of fact. Estate of
Newhouse v. Commissioner, 94 T.C. 193, 217 (1990). The parties’ experts offer
different conclusions regarding the value of the transferred interest based on
differing interpretations of the relevant facts. However, we are not bound by the
opinion of any expert witness when that opinion is contrary to our own judgment.
Estate of Hall v. Commissioner, 92 T.C. 312, 338 (1989). We resolve the
valuation issue on the preponderance of the evidence in the record with the
guidance of those expert opinions that we find most helpful.
III. Type of Interest
The parties disagree as to the type of interest that must be valued and
included in the value of decedent’s gross estate.2 The estate contends that the
2
The parties agree that the value of decedent’s interest in Streightoff
Investments transferred to the revocable trust is includible in the value of the gross
(continued...)
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[*15] agreement created an assignee interest in decedent’s limited partnership
interest under Texas State law and the partnership agreement. It contends that it
valued and reported decedent’s interest in the revocable trust correctly as an
assignee interest on Schedule G of its tax return.
Respondent contends that the agreement did not create an assignee interest
held by the revocable trust. Respondent argues that decedent transferred his
88.99% limited partnership interest to the revocable trust and the value to be
included in the value of the gross estate should be that of a limited partnership
interest.
We need to determine whether the interest decedent transferred to the
revocable trust was a limited partnership interest or an assignee interest.
Generally, State law determines the property interest that has been transferred for
Federal estate tax purposes. See McCord v. Commissioner, 120 T.C. 358, 370
(2003), rev’d and remanded on other grounds, 461 F.3d 614 (5th Cir. 2006).
TRLPA (as in effect for the relevant period) provides that a partnership interest is
personal property and is assignable, in whole or in part, unless the partnership
agreement provides otherwise. Tex. Rev. Civ. Stat. Ann. art. 6132a-1, secs. 7.01
2
(...continued)
estate pursuant to sec. 2038.
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[*16] and 7.02(a)(1) (West). An assignee of a partnership interest is entitled to
receive, to the extent assigned, allocations of income, gain, loss, deduction, credit,
or similar items, and to receive distributions to which the assignor is entitled, but
an assignment does not entitle the assignee “to become, or to exercise rights or
powers of, a partner”. Id. sec. 7.02(a)(2) and (3). The assignee may become a
limited partner, with all rights and powers of a limited partner under a partnership
agreement, in the manner that the partnership agreement provides or if all partners
consent. Id. sec. 7.04(a) and (b).
Although we consult State law to determine what property interests were
transferred, our inquiry may not end there. See McCord v. Commissioner, 120
T.C. at 371. The Federal tax effect of a particular transaction is governed by the
substance of the transaction rather than its form. Frank Lyon Co. v. United States,
435 U.S. 561, 573 (1978). The doctrine that the substance of a transaction will
prevail over its form has been applied in Federal estate and gift tax cases. See
Heyen v. United States, 945 F.2d 359, 363 (10th Cir. 1991); Estate of Murphy v.
Commissioner, T.C. Memo. 1990-472. In particular, we have indicated a
willingness to look beyond the formalities of intrafamily partnership transfers to
determine what, in substance, was transferred. See Kerr v. Commissioner, 113
T.C. 449, 464-468 (1999), aff’d, 292 F.3d 490 (5th Cir. 2002). We will consider
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[*17] both the form and the substance of decedent’s transfer to the revocable trust
to determine whether the property interest transferred was an assignee interest or a
limited partnership interest.
The partnership agreement in this case allowed for transfers of limited
partnership interests and for the admission of substituted limited partners. Section
9.6 provided that a transferee who was not admitted as a substituted limited
partner would hold the right to allocations and distributions with respect to the
transferred interest but would have no right to any information or accounting or to
inspect the books or records of the partnership and would not have any of the
rights of a general or limited partner (including the right to vote on partnership
matters). Under section 9.7 conditions had to be met for the admission of a
transferee of a partnership interest as a substituted limited partner. The estate
contends that these conditions were never met with respect to the interest that
decedent transferred to the revocable trust and that upon the execution of the
agreement the revocable trust received only an assignee interest in decedent’s
88.99% limited partnership interest.
The agreement provided that decedent made a transfer to the revocable trust
of “[a]ll of * * * [his 88.99%] limited partnership interest” in Streightoff
Investments. It further stated that decedent transferred with the interest “all and
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[*18] singular the rights and appurtenances thereto in anywise belonging”.
Although the transfer was labeled an “[a]ssignment”, the agreement states that the
revocable trust is entitled to all rights associated with the ownership of decedent’s
88.99% limited partnership interest, not those of an assignee. All “rights and
appurtenances” belonging to decedent’s interest include the right to vote as a
limited partner and exercise certain powers as provided in the partnership
agreement.
The agreement provided that decedent was bound to provide any
documentation or execute any legal instruments necessary “to provide * * * [the
revocable trust] all the rights * * * [decedent] may have had” in the limited
partnership interest. Decedent’s rights in the limited partnership interest were
those of a limited partner in the partnership. The agreement satisfied all the
conditions for the transfer of decedent’s limited partnership interest and the
admission of the revocable trust as a substituted limited partner.
Section 9.7 provided that for a transferee to be admitted as a substituted
limited partner in respect of a transferred interest in Streightoff Investments (1) the
general partner must consent to the transferee’s admission, (2) the transferee must
have acquired the interest by means of a permitted transfer, and (3) the transferee
must agree and execute the instruments necessary to be bound by the terms of the
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[*19] partnership agreement. Ms. Streightoff signed the agreement as manager of
Streightoff Investments’ general partner and gave consent to its terms, which
provided for the transfer of all of decedent’s rights in the limited partnership
interest to the revocable trust. The parties have stipulated that the transfer was a
permitted transfer. Lastly, the agreement provided that the revocable trust agreed
to abide by all terms and provisions of the partnership agreement, and Ms.
Streightoff executed the agreement on behalf of the revocable trust.
We conclude that the form of the agreement establishes that decedent
transferred to the revocable trust a limited partnership interest and not an assignee
interest. The economic realities underlying the transfer of decedent’s interest also
support our conclusion that the transferred interest should be treated as a limited
partnership interest for Federal estate tax purposes. This is because we conclude
that regardless of whether an assignee or a limited partnership interest had been
transferred, there would have been no substantial difference before and after the
transfer to the revocable trust. See Kerr v. Commissioner, 113 T.C. at 467-468.
Pursuant to Streightoff Investments’ partnership agreement only the general
partner had the right to direct the partnership’s business; neither limited partners
nor assignees had managerial rights. The partnership agreement provided that
assignees had no rights to any information regarding the business of the
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[*20] partnership or to inspection of the books or records of the partnership.
However, this distinction made no difference in this case because Ms. Streightoff
was both a partner entitled to information regarding Streightoff Investments and
the trustee of the revocable trust.
The partnership agreement provided that an “unadmitted assignee” did not
have the right to vote as a limited partner. In Kerr v. Commissioner, 113 T.C. at
467, we determined that the only real difference between the rights of a limited
partner and those of an assignee was the right to vote on partnership matters, and
we concluded that this difference was not significant. We held that under such
circumstances the transferred interest should be valued as a limited partnership
interest rather than as an assignee interest. Id. Here, we conclude similarly that
whether the revocable trust held the voting rights associated with a limited
partnership interest would have been of no practical significance.
There were no votes by limited partners following the execution of the
agreement. Additionally, during his life decedent held the power to revoke the
transfer to the revocable trust. If he had revoked the transfer, he would have held
all the rights of a limited partner in Streightoff Investments, including the right to
vote on partnership matters. Also, Streightoff Management as the general partner
could have treated the holder of an assignee interest as a substitute limited partner.
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[*21] Under the facts and circumstances of this case, there was no difference in
substance between the transfer of a limited partnership interest in Streightoff
Investments and the transfer of an assignee interest in that limited partnership
interest. See id.; Astleford v. Commissioner, T.C. Memo. 2008-128, slip op. at 16.
Accordingly, as a matter of both form and substance, the interest to be valued for
estate tax purposes is an 88.99% limited partnership interest in Streightoff
Investments.
IV. Fair Market Value
Generally, the value of an item of property included in the value of a
decedent’s gross estate is the fair market value of the item at the time of the
decedent’s death or, if an election is made, on the alternate valuation date. See
sec. 20.2031-1(b), Estate Tax Regs. “The fair market value is the price at which
the property would change hands between a willing buyer and a willing seller,
neither being under any compulsion to buy or to sell and both having reasonable
knowledge of relevant facts.” Id. The hypothetical willing buyer and the
hypothetical willing seller are presumed to be dedicated to achieving the
maximum economic advantage. See Estate of Davis v. Commissioner, 110 T.C.
530, 535 (1998).
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[*22] Both parties submitted expert reports regarding the fair market value of the
interest that decedent transferred to the revocable trust. Juliana Vicelja was
respondent’s expert, and Oliver Warnke and Alan Harp, employees of Howard
Frazier Barker Elliot, Inc. (HFBE), were experts for the estate.
Both parties’ experts characterize the partnership as an asset holding entity.
They employed valuation methods that determined the value of the transferred
interest in Streightoff Investments as 88.99% of the NAV of the partnership, less
certain discounts. The parties have stipulated the NAV of the partnership on the
alternate valuation date.
A. Lack of Control
Ms. Vicelja’s report determines that decedent’s limited partnership interest
holds considerable influence and control over the management of Streightoff
Investments because of specific provisions in the partnership agreement. The
report notes that under article V limited partners with a 75% interest hold the
power to remove general partners, and under section 1.5 a general partner’s
removal terminates the partnership. It states that a prospective purchaser of
decedent’s 88.99% limited partnership interest would pay more for the degree of
control embodied in the interest, including the ability to unilaterally terminate the
partnership if he or she does not agree with the management of the general partner.
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[*23] Her report concludes that no discount for lack of control should be applied
to the interest.
HFBE’s report assumes that the interest to be valued is an assignee interest
in decedent’s limited partnership interest and that a hypothetical buyer would pay
less for an interest that does not give the holder access to or control over the
underlying assets of the partnership. The report acknowledges that the partnership
agreement provided limited partners with the right to vote on decisions affecting
partnership management, including the removal of the general partner and
termination of the partnership, but determines that the interest at issue would
provide none of these control benefits because it was an assignee interest. It
concludes that a 13.4% discount for lack of control should be applied in valuing
the interest.
Since we have determined that the interest transferred was an 88.99%
limited partnership interest, we conclude that the interest did not lack control.
Accordingly, there is no discount for lack of control.
B. Lack of Marketability
Both parties’ experts relied on factors identified in Mandelbaum v.
Commissioner, T.C. Memo. 1995-255, 1995 WL 350881, aff’d, 91 F.3d 124 (3d
Cir. 1996), to determine a discount for lack of marketability. These factors, which
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[*24] generally make an interest in an entity more or less marketable, include:
(1) an analysis of the entity’s financial condition, (2) the entity’s capacity to pay
and history of paying distributions, (3) the nature of the entity and its economic
outlook, (4) the management of the entity, (5) the amount of control held by the
interest, (6) restrictions on the transferability of the interest, (7) the required
holding period for the interest, (8) the entity’s redemption policy, and (9) the costs
associated with making a public offering. Id. at *11.
Respondent’s expert report states that generally no ready market exists for
sales of interests in privately held entities and a discount for lack of marketability
is necessary to entice prospective buyers. In quantifying an appropriate
percentage discount for lack of marketability Ms. Vicelja relies on data from
restricted stock studies. These studies reflect that discounts for lack of
marketability for restricted stocks have decreased in more recent years. This trend
is linked to amendments in Securities and Exchange Commission (SEC)
regulations that shortened the holding periods required for purchasers of restricted
stocks to resell their interests. Ms. Vicelja determined the appropriate discount for
lack of marketability for the transferred interest using more recent studies, which
considered stocks with shorter holding periods.
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[*25] Ms. Vicelja determined that Streightoff Investments was capable of making
distributions during each of the years under consideration and that the
partnership’s overall financial condition and prospects are strong. Her report
notes that the underlying assets of Streightoff Investments are highly liquid. She
testified that the diversification and high liquidity of the assets would make an
interest in the partnership highly attractive to a hypothetical buyer. The report
determines that the amount of control provided by an 88.99% limited partnership
interest is a factor favoring a lower discount. It also asserts that the right of first
refusal provided for in the partnership agreement warrants a lower discount. Her
report concludes that a discount for lack of marketability of 18% is appropriate.
The HFBE report asserts generally that longer required holding periods,
riskier entities, and lower prospects for distributions indicate that a higher
discount should be applied than that which respondent determined. Like Ms.
Vicelja’s report, the HFBE report cites data from restricted stock studies.
However, it relies on older studies conducted when SEC regulations imposed the
longest holding period requirements for restricted stocks. The estate’s expert
report assumes that the interest to be valued is an assignee interest and that the
holder would have no ability to force liquidation. The report concludes that the
predicted holding period required for the subject interest indicates a higher
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[*26] discount relative to those reflected in the restricted stock studies. Mr. Harp
testified that “a very long holding period expected * * * [is] one of the main
drivers for lack of marketability discount”.
The HFBE report states that the risk profile for an asset holding entity like
Streightoff Investments is low compared to those of the operating companies that
were considered in the restricted stock studies. It determines that, overall, the risk
factors for the partnership indicate a lower discount for the interest at issue. With
respect to the impact of the partnership’s distribution policy, the report relies on
statements made by partnership representatives that the partnership does not
intend to make distributions in excess of the partners’ tax liabilities for the
foreseeable future. It acknowledges that the majority of the companies considered
in the restricted stock studies also did not pay dividends but determines that the
partnership’s distribution policy warrants an increase in the applicable discount.
The HFBE report concludes that a 27.5% discount for lack of marketability
is appropriate to apply to the transferred interest. Mr. Harp testified that his
analysis for the lack of marketability discount would have included different
considerations if the interest was a limited partnership interest with voting rights
under the partnership agreement.
- 27 -
[*27] We agree with the experts that there should be a discount for the lack of
marketability. The estate’s experts took into consideration that the interest they
were valuing was an assignee interest, and this affected the conclusion in their
report. Since we concluded that the interest decedent transferred was a limited
partnership interest, the estate’s experts’ valuation is too high. The analysis in
respondent’s expert report is reasonable. We conclude that the interest should be
valued using an 18% discount rate for lack of marketability.
We have considered all of the arguments made by the parties, and to the
extent we did not mention them above, we conclude that they are moot, irrelevant,
or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.