Transferring a portion of the partnership to Cindy and Luke by way of a gift is not ideal, due to the
value of the property would be the fair market value at the time the property is gifted. John may want
to consider limited partnership. d A company that is held by two or more family members is known as
a family limited partnership (FLP). FLP are created to safeguard a family's generational wealth by
permitting the transfer of assets, real estate, and other forms of wealth without paying taxes. With the
ability to transfer assets, real estate, and other types of wealth tax-free, FLPs are frequently created.
FLP can be general or limited and in this case the transfer of property from John to his children be
limited noncontrolling, to take advantage of minority interest discount.
When considering a partial transfer of ownership in a business, it's important to choose the
appropriate business structure. In my opinion, for this case a limited partnership would be a good
choice. A limited partnership consists of at least one general partner who has unlimited legal liability
and manages the business, and one or more limited partners who have limited liability but do not
participate in the day-to-day operations of the business. This structure allows for the transfer of
ownership while maintaining the current owner's control over the business. In this scenario, John can
remain as the general partner and transfer partial ownership to his two adult children, Cindy and
Luke, as limited partners. The value of the business is currently at $10,000,000, and each person's
proportionate share would be 1/3. However, to achieve a fair market value of the transfer that is less
than Cindy and Luke's proportionate share of the $10,000,000 value, valuation discounts can be
applied.
Valuation discounts are used to adjust the value of an ownership interest in a business to reflect the
fact that the interest is not easily marketable or lacks control. Two common types of valuation
discounts are minority interest discounts and lack of marketability discounts. A minority interest
discount is applied when a person owns less than 50% of the business. The rationale is that the person
does not have control over the business, which makes their ownership interest less valuable. A
minority interest discount can range from 10% to 50%, depending on the circumstances of the
business. A lack of marketability discount is applied when an ownership interest is in a non-publicly
traded business. This type of discount reflects the fact that the ownership interest cannot be easily
sold or transferred like a publicly traded stock. A lack of marketability discount can range from 20%
to 50%, depending on the business.
It is important to note that the use of valuation discounts can be controversial and can raise concerns
about accuracy. The IRS has challenged the use of valuation discounts in the past and has issued
regulations and rulings to limit their use. One example of this is Treasury Regulations section
25.2704-1, which provides that certain restrictions on the ability to liquidate an ownership interest
may be disregarded for valuation purposes if the restriction will lapse after the transfer or if the
transferor or family members retain certain control rights.
Another example that I was able to find is the Revenue Ruling 93-12, which provides guidance on the
use of discounts for lack of marketability and minority interest in the context of intra-family transfers.
This ruling specifies that discounts may be appropriate for lack of marketability and minority interest,
but only if they are supported by a qualified appraisal and are not artificially created through
restrictions that are not bona fide business arrangements. To sum it up, in order to structure a partial
transfer of ownership in a business, a limited partnership may be a good choice. To achieve a fair
market value of the transfer that is less than the proportionate share of the business's value, valuation
discounts can be applied, such as minority interest discounts and lack of marketability discounts.
However, it's important to be aware of the IRS regulations and rulings regarding the use of these
discounts to ensure compliance and accuracy.
Hope your weeks are going well, moving right along into the first third done. If Cindy and Luke do
not have time to be part of the day-to-day workings of the company, then a limited partnership sounds
like a good way to make them part of the company without them having to make decisions while
John is still running the business. In a Limited partnership, John would remain as the general partner
with unlimited personal liability like he did before in the sole proprietorship (Shweta, 2022). But
Cindy and Luke would be limited and have limited liability also known as silent partners (Shweta,
2022). When it comes to the taxes a Schedule K-1 would be filed and passed through the losses,
deductions, credits and earnings to the general partner, John (Shweta, 2022). “Limited partners do not
have to pay self-employment taxes; only general partners have to do so” and the earnings are
considered passive earnings or losses (Shweta, 2022).
To maximize the benefits of a FLP (family limited partnership would be to make both Cindy and
Luke 0.17% partners and increase this each year following the gift tax yearly limit (Kennon, 2023).
This would take advantage of the yearly gift tax without cutting into the estate tax exclusion limit
(Kennon, 2023). d And as their percentages increased the profits from the company would continue to
pass to them (Kennon, 2023). Because of the current laws the estate tax will be dropping back down
to ~6 million by 2026. Because of this by giving both Cindy and Luke 30% will keep them below the
Estate tax, John could keep giving shares to them each year staying within the yearly gift tax limit
(Kennon, 2023).
Valuation Discounts could be used to adjust the value of the owner’s interest. There are minority
discounts and lack of marketability discount and future interest discounts (Rutan & Cfp, 2021). Lack
of marketability is when “refers to calculating the value of closely held businesses or restricted shares
of public companies” (Rutan & Cfp, 2021). This can range from 20 to 50% (Rutan & Cfp, 2021).
Minority share is when “a partial ownership interest may be worth less than its pro rata (proportional)
share of the total business” (Rutan & Cfp, 2021). This discount can range from 10 to 50% (Rutan &
Cfp, 2021
When there is a substantial understatement of value of 65% or 35% wrong then under section 6662
this could cause an additional 20% tax of the original underpayment. This could also cause a red flag
and make the IRS more likely to watch your partnership. This is also the reason that the IRS currently
watches family partnerships very closely.
Kennon, J. (2023, January 17). How Family Limited Partnerships Can Lower Gift and Estate Taxes.
The Balance. Retrieved May 4, 2023, from https://www.thebalancemoney.com/family-limited-
partnership-gifts-358121
Rutan, C., & Cfp, V. K. (2021, October 12). Valuation Discounts for Gift and Estate Tax Savings.
CAPTRUST. Retrieved May 5, 2023, from https://www.captrust.com/valuation-discounts-for-gift-
and-estate-tax-savings/
Shweta. (2022, September 28). What Is A Limited Partnership? Definition, Pros And Cons. Forbes
Advisor. Retrieved May 4, 2023, from https://www.forbes.com/advisor/business/what-is-limited-
partnership/
Legal Information Institute. (n.d.). 26 CFR § 25.2704-1 - lapse of certain rights. Legal Information
Institute. Retrieved May 1, 2023, from https://www.law.cornell.edu/cfr/text/26/25.2704-1
Revenue ruling 93-12. (n.d.). Retrieved May 1, 2023, from http://s-corp.org/wp-
content/uploads/2016/08/IRS-Revenue-Ruling-93-12.pdf
