Steve Akers's Summary of Holman v. Commissioner, 105 AFTR 2d ¶ 2010-721 (8th Cir. April 7, 2010)

The Eighth Circuit Court of Appeals has affirmed the Tax Court's decision (at 130 T.C. 170 (2008)). The indirect gift/step transaction doctrine issue, which would have eliminated all discounts in determining the gift tax value, was decided in the taxpayer's favor by the Tax Court. The government did not appeal that issue.

The Eighth Circuit (by a 2-1 split of the three-judge panel) affirmed the Tax Court's conclusion that transfer restrictions in the agreement must be ignored under §2703 in valuing the transfers. (The court reasoned that the transfer restrictions did not satisfy the "bona fide business arrangement" requirement in the §2703(b) safe harbor.)

The Tax Court found that the lack of marketability discount was only 12.5%, partly based on a consideration that the remaining partners would have an economic interest to purchase an interest for a value somewhere between the discounted price that a third party was willing to pay and a pro rata share of net asset value, thus placing a floor on the marketability discount. The Eighth Circuit majority opinion affirmed that approach and held that it did not violate the hypothetical willing buyer/willing seller valuation standard.

There was a strong dissent as to both the §2703 and the marketability discount issue.

The case overall is still a taxpayer victory -- gifts were made of a partnership interests holding only one marketable stock with a 22.4% overall lack of control and marketability discount for the most significant gift. Some of the reasoning in the case, however, is quite troubling for planners if future courts follow the same approach of this Tax Court (regular opinion, not just a Memorandum decision) and Eighth Circuit case:
Section 2703 will likely not allow considering transfer restrictions in valuing FLP interests for most investment partnerships;
The Tax Court's reasoning for concluding that the "device" requirement of the §2703 safe harbor was not met would suggest that many buy-sell agreements for even operating businesses would not be respected for transfer tax valuation purposes, and it is most troubling that the Eighth Circuit did not take the opportunity to revise that reasoning (the Eighth Circuit did not address this issue at all); and
The reasoning suggests a major inroad on the hypothetical willing buyer/willing seller valuation standard by taking into consideration that remaining partners would likely purchase the interest of any exiting partner at a price higher than what a third party would pay; the 12.5% marketability discount is very low and IRS agents will likely be citing this case routinely in future audits to support a low marketability discount.

Click here for a summary of Holman with planning implications.