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. d 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. 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%. 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/17354
2/pages/589?locale=&isTpi=Y&redirectURL=https://plus.pearson.com/bookshelf&use
rPreferredType=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_profess
ional_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/professionalrespo
nsibilities#:~:text=Additionally%2C%20all%20AICPA%20members%20are,client%20confidentiality
%2C%20disclose%20to%20the
