The Tax Court recently held that a father's transfer of property to a family limited partnership (FLP) was not a gift and that §2704(b) does not apply because the FLP's restrictions on transfer and liquidation of partnership interests are not applicable restrictions.

On January 1, 1995, W.W. Jones II formed two FLPs, one (FLP1) with his son and another (FLP2) with his four daughters. He transferred his cattle ranch properties to both FLPs in exchange for limited partnership interests (95% and 88%, respectively). Jones's son and daughters contributed real property to their FLPs in exchange for general and limited partnership interests. On the same day, Jones transferred to his son and daughters the majority of his limited partnership interests in each FLP. Jones was left with a 12.5% limited partnership interest in FLP1 and a 20.5% interest in FLP2.

The IRS determined a 1995 gift tax deficiency of over $4 million, claiming that Jones's transfers to the FLPs were taxable gifts. Jones subsequently died in 1998. Using the values reported by the decedent on his gift tax return for 1995, the IRS reasoned that he gave up property worth over $17 million and received limited partnership interests worth $6.6 million, and he made taxable gifts upon the formation of the FLPs equal to the difference in value. The IRS also argued that the restrictions on liquidation and transfer of partnership interests were more restrictive than the limitations that would generally apply to the FLPs under state (Texas) law. Therefore, the IRS claimed, those restrictions should be ignored under §2704(b) for the purpose of determining valuation discounts.

Tax Court Judge Mary Ann Cohen looked to Estate of Strangi v. Commissioner, 115 T.C. 478, 489-490 (2000), a similar case in which a decedent had formed a FLP, transferred assets to it, and received limited partnership interests in return worth substantially less than the assets contributed. In both cases, the decedent had received a continuing interest in the FLP and his contribution had been allocated to his own capital account. In Estate of Strangi, the Court held that under these circumstances, the decedent had not made taxable gifts. Judge Cohen stuck to the precedent and held that Jones had not made a gift at the time of contribution.

The Court also disagreed with the alternative argument made by the IRS that the discounts for lack of control and marketability should be ignored under §2704(b). Again, Judge Cohen looked to a similar past case (Kerr v. Commissioner, 113 T.C. 449, 469-474 (1999)), in which the Court rejected essentially identical arguments. The IRS contended that the decision in Kerr was incorrect, but Judge Cohen found no reason to question the result in the case.

You can view the text of the decision on the Tax Court web site at: