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Tax Court Uses Hybrid Method To Determine Valuation of Limited Partnership Interest

More from the world of estate taxation from WS+B expert Hal Terr:

In Estate of Natale B. Giustina v. Commissioner, T.C. Memo 2011-141, the Tax Court used a part cash flow, part asset methodology to determine the date of death value of a 41.128% limited partnership interest included in the decedent’s gross estate.   Although the Tax Court’s valuation was more than 50% higher than the value reported on the estate tax return, the Tax Court found the estate was not subject to the 20% accuracy-related penalty because the estate met the reasonable cause exception.

In 1990, Natale Giustina’s family created the “Giustina Land & Timber Co. Limited Partnership” and transferred their interest in the family timber business to this partnership.   Natale Giustina owned a 41.128% limited partnership interest in the new entity.   At the time of Giustina passing, the value of the timberlands owned by the partnership was agreed to be $142,974,438.  On the estate tax return, the value of the limited interest was reported to be $12,678,117. 

At trial, the IRS argued that  the value of the limited interest was $33,515,000.  The estate and the IRS each had expert witnesses testify to the value of the limited partnership interest.   The Tax Court found faults in each expert’s valuation calculations. 

The court did not agree with the IRS’s determination of the discounted cash flow from the partnership, nor did it agree with the estate expert’s 25% reduction for income taxes when determining the discounted cash flow or the discount rate used.  The estate argued for a 35% marketability discount, but the Tax Court agreed with the IRS expert, and settled on a 25% marketability discount. 

The IRS expert gave a 30% weight to the cash flow method while the estate’s expert applied a 20% weight.  The Tax Court disagreed with both experts and applied a 75% weight to the cash flow method given the higher probability that the partnership would have continued its operations rather than liquidating its assets. 

In addition, the court applied a 25% weight to the valuation of the timberlands.   The result was a limited partnership interest valuation of $27,454,115.

Since the Tax Court’s value of the limited partnership was more the 50% higher than the value reported by the estate, the IRS assessed a 20% accuracy related penalty of approximately $2.5 million.  Under IRC Section 6664(c)(1), no penalty is imposed with respect to an underpayment if there was reasonable cause for the underpayment and the taxpayer acted in good faith.   The Tax Court determined that the penalty should not be assessed since the executor hired an attorney to prepare the estate tax return, a valuation firm to appraise the limited partnership interest and the executor relied on the appraisal in filing the return.  Although the appraisal did not incorporate the asset method, the Tax Court found it was reasonable for the executor to rely on the appraisal and the valuation was made in good faith and with reasonable cause.

 What can be learned from this decision by the Tax Court?   Until legislation is enacted by Congress, the IRS will continue its attack of family limited partnership and the valuation discounts for lack of marketability and control, specifically those partnerships funded with passive assets.   In addition, the decision highlights just the differing views the IRS and the taxpayer often have in valuing the same limited partnership interest.  However, by hiring the right advisors and acting in a diligent and prudent manner, tapayers can avoid application of the 20% accuracy related penalty.