John has a sole proprietorship business which is worth $ 10,000,000, and he intends to transfer the
portion of its ownership to his adult children Cindy and Luke. For dividing the business between his
children, limited partnership is an appropriate structure. It will ensure that both the children are
partners have limited liability (Chen, 2022). Moreover, it will also enable John to have a control over
the day-to-day operations of the business and ensure that it runs smoothly. In order to structure the
ownership transfer so that a fair market value of the transfer can be achieved that is less than Cindy
and Luke's proportionate share of the $10,000,000 value, the viable option is utilizing valuation
discounts. Valuation discounts serve as useful instruments that can help to minimize the value of an
asset for the purpose of taxation. c However, while adopting the method it is instrumental to adhere
to AICPA Code of Professional Conduct. The structure change must be done in a competent and
honest manner so that the process will be legal and ethical in nature (Professional responsibilities.
AICPA.).
According to the American Bar Association (ABA), emphasis must be laid on due diligence,
truthfulness of statements with others, etc. (Americanbar.org). In the specific scenario, there is an
opportunity for John to create a family limited partnership so that he could transfer his
proprietorship business to it. By taking such a step it will be possible for both of his adult children to
have limited control over the assets that are under the family limited partnership. It has been
identified as a suitable step since it will enable John to lower the fair market value of his machine
shop business.
However, while adopting the valuation discount option, it is essential for John to ensure that the
valuation is done in a fair and accurate manner. c c According to Koste (2009), the Internal Revenue
Service (IRS) can minimize the valuation discounts that is afforded to family limited partnerships.
Hence John must ensure that the strategy that is adopted by him meets all the necessary legal
requirements.
In case the valuation that is made by John is found to be inaccurate, it can give rise to penalty issues
relating to the valuation discounts of the proposed transfer. Some of the main forms of penalties
that may arise in case inaccuracies or mistakes are identified in valuation discounts include fines, as
well as criminal charges.
"Section 25.2512-1 of the Gift Tax Regulations provides that, if a gift is made in property, its value at
the date of the gift shall be considered the amount of the gift. The value of the property 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." (Revenue Ruling, N.d) In this case, John should set up a partnership and be the general
manager transfer partial ownership to his daughter and son as the limited partners. His initial
contribution of the property to the partnership would not be subject to income tax because the
transfer of property to a partnership in exchange for a partnership interest is generally tax-free
under Section 721 of the Internal Revenue Code. Unless in the future the partnership decided to sell
then the partners could be subject to tax on their share of the gain. The current valuation of the
business is at 10,000,000, this business could be separated any way but the easiest is to separate 3
ways, with each party getting 33%. c To achieve the a FMV that is lower than the share valuation
discounts must be applied. Valuation discounts are the difference in value between a company's
peers in the same industry to that a buyer assesses. Some examples that may help in this case are
minority interest discounts and lack of marketability discounts which can be applied with or without
controlling interest. A minority interest discount is applied when a person owns less than 50% of the
business. The discount can range from 20% to 50% it is entirely dependent on the type of business.
Lack of marketability discounts discount is for cases where the ownership interest cannot be easily
sold or transferred like a publicly traded stock. We see through cases like Andrews vs United States
where "Although appealing because of the simplicity, we must reject respondent's methodology in
valuing the contract right of the decedent."
Estate of Curry v. Commissioner, 74 T.C. 540, 548, 1980 U.S. Tax Ct. LEXIS 118, *20 (T.C. June 9, 1980)
We can also see that the IRS in the past has challenged the use of valuation discounts and has issued
regulations and rulings to limit their use. The concerns would be if the IRS found the valuation to be
different and the clients had to pay increased tax.
References:
Anderson, Kenneth and Hulse, David and Rupert, Timothy Pearson (2023) Taxation 2023
Corporations, Partnerships, Estates; Trusts Retrieved on:
https://plus.pearson.com/courses/c5bbf0f3f5514da496e7aa394b970921_d2l_snhumlp/products/17
3542/pages/589?locale=&isTpi=Y&redirectURL=https://plus.pearson.com/bookshelf&
userPreferredType=read
Fritz, Farrell (October 30, 2018) Family Limited Partnerships – They’re Still Out There (?)
Revenue ruling 93-12. (n.d.). Retrieved May 2, 2023, from http://s-corp.org/wp-
content/uploads/2016/08/IRS-Revenue-Ruling-93-12.pdf
Americanbar.org. (n.d.). Retrieved May 4, 2023, from
https://www.americanbar.org/groups/professional_responsibility/publications/model_rules_of_prof
essional_conduct/model_rules_of_professional_conduct_table_of_contents/
Chen, F. (2022). Comparison Between Companies and Partnerships. In Essential Knowledge and
Legal Practices for Establishing and Operating Companies in China (pp. 15-19). Singapore: Springer
Nature Singapore.
Koste, A. (2009). The IRS Fished Its Wish: The Ability of Section 2703 to Minimize Valuation
Discounts Afforded to Family Limited Partnership Interests in Holman v. Commissioner. Cath. UL Rev.,
59, 289.
Professional responsibilities. AICPA. (n.d.). Retrieved May 4, 2023, from
https://us.aicpa.org/interestareas/personalfinancialplanning/resources/practicecenter/professionalr
esponsibilities#:~:text=Additionally%2C%20all%20AICPA%20members%20are,client%20confidentialit
y%2C%20disclose%20to%20the
