May 30, 2019

Estate of Streightoff v. Comm’r, T.C. Memo. 2018 178

A valuation case from the Tax Court addressing the type and value of an interest transferred to a trust.

Benjamin A. Cohen-Kurzrock

CASE SUMMARY†

Estate of Streightoff v. Comm’r, T.C. Memo. 2018‑178

On October 24, 2018, the Tax Court released a memorandum opinion authored by Judge Kerrigan, captioned Estate of Frank D. Streightoff, Deceased, Elizabeth Doan Streightoff, Executor v. Commissioner of Internal Revenue, T.C. Memo. 2018‑178.  The case arose from an estate tax deficiency of $491,750 and raised an issue regarding the type and value of an interest in a closely held entity that the decedent transferred to his revocable trust.  This case summary summarizes that opinion. 

I.                Facts

A.              Streightoff Investments, LP and Streightoff Management, LLC

On October 1, 2008, the decedent, through his daughter Elizabeth Doan Streightoff (“Elizabeth”), who held the decedent’s power of attorney, formed Streightoff Investments, LP, a Texas limited partnership (“Streightoff Investments”).  Streightoff Management, LLC (“Streightoff Management”) was Streightoff Investments’ sole general partner and was managed by Elizabeth, in her individual capacity.  The initial limited partners were the decedent, his daughters, and his former daughter‑in‑law, each of whom received her interest upon formation by a gift from the decedent that was reported on his 2009 gift tax return.  The decedent funded Streightoff Investments with cash and marketable debt and equity investments (e.g., stocks, bonds, and other investments). 

Streightoff Investments’ partners entered into a limited partnership agreement, which included the following relevant provisions:

  • the general partner controlled the partnership, subject only to limitations set forth expressly in the partnership agreement;
  • the partnership would terminate on December 31, 2075, unless sooner terminated by the happening of certain events (e.g., the removal of the general partner, which could occur by written agreement of the limited partners holding at least 75% of the partnership interests held by all partners);
  • interests in the partnership were subject to transfer restrictions under which, except in the case of a transfer to a “permitted transferee” (i.e., any member of the transferor’s family; the transferor’s executor, trustee, or personal representative obtaining such interest at death or by operation of law; or to any purchaser, subject to the right of first refusal provided for in the partnership agreement), which was not restricted; a limited partner could not sell or assign the partner’s interest without obtaining written approval of the general partner; and in the case of an assignment absent that agreement, the transferor would continue to have certain obligations to the partnership until the transferee, who would be treated as holding an assignee interest entitled only to allocations and distributions, was admitted as a partner; and
  • Priority family members (i.e., the transferor’s spouse, natural or adopted lineal ancestors or descendants, and trusts for their exclusive benefit), the partnership, and the general partner had a right of first refusal under which each had the opportunity to acquire the interest of a partner who received an outside purchase offer for such interest at the same or better terms than those offered by the outside purchaser.

B.              The Frank D. Streightoff Revocable Living Trust

On October 1, 2008, the decedent established the Frank D. Streightoff Revocable Living Trust (the “Living Trust”).  On the same day, he, through Elizabeth as his attorney‑in‑fact, assigned to the Living Trust (a permitted transferee under the Streightoff Investments’ partnership agreement) his 88.99% limited partnership interest in Streightoff Investments.     

C.              The Estate Tax Return and Notice of Deficiency

The decedent, a Texas resident, died on May 6, 2011, and Elizabeth was the executor of the decedent’s estate (the “Estate”).  On August 8, 2012, Elizabeth filed the estate tax return and reported a gross estate less exclusions of $5,051,299 as of November 6, 2011, using the alternative valuation date. 

On November 6, 2011, Streightoff Investments had a net asset value (“NAV”) of $8,212,103.  The decedent’s interest in Streightoff Investments was reported as an 88.99% assignee interest with a value of $4,588,000, after applying a 37.2% discount.  In its notice of deficiency, the Commissioner determined that the decedent’s interest in Streightoff Investments had a value of $5,993,000. 

II.             The Tax Court’s decision

After readily dispensing with the Estate’s challenge to the notice of deficiency, which the Estate previously lost on summary judgment, the Tax Court focused its analysis on two principal issues: (1) the nature of the property interest transferred by the decedent to the revocable trust and (2) the value of that interest as of the alternate valuation date.

A.              Nature of the Transferred Interest

The Estate and the Commissioner disagreed over whether the 88.99% interest in Streightoff Investments held by the Living Trust was an assignee interest or a limited partnership interest.  The Tax Court acknowledged that, generally, “[s]tate law determines the property interest that has been transferred for estate tax purposes.”  Id. at 15 (citing McCord v. Comm’r, 120 T.C. 358, 370 (2003), rev’d and remanded on other grounds, 461 F.3d 614 (5th Cir. 2006)).  But, the substance of a transaction, rather than its form, can adjust the ultimate tax effect of the determination under state law. 

The Tax Court, therefore, considered the form and the substance of the decedent’s transfer to the Living Trust to determine the nature of its interest in Streightoff Investments, ultimately concluding that the transferred interest was a limited partnership interest.  Two principal reasons supported the Tax Court’s conclusion: first, a limited partnership interest was transferred in form because the assignment was sufficient for transferring a limited partnership interest in Streightoff Investments and admitting the Living Trust as a partner; and second, in this case, there was no material[i] difference between a limited partnership interest and an assignee interest.  Thus, “as a matter of both substance and form, the interest to be valued for estate tax purposes [was] an 88.99% limited partnership interest in Streightoff Investments.”  Id. at 21.      

B.              Value of the Transferred Interest as of the Alternate Valuation Date

The Tax Court reiterated well‑known standards for gift and estate tax valuations: (1) the fair market value of an interest is a question of fact that is aided (but not controlled) by expert opinions; (2) that value is the price at which the property would change hands between a willing buyer and a willing seller under no compulsion to buy or sell and both having reasonable knowledge of relevant facts; and (3) the hypothetical willing buyer and seller are presumed to be dedicated to achieving maximum economic advantage. 

The parties relied on expert opinions to determine the value of the transferred interest in Streightoff Investments.  The experts agreed that, because Streightoff Investments was an asset holding company, the most appropriate method for valuing the transferred interest was based on its pro rata NAV less discounts.  While the NAV was stipulated, the experts disagreed over the appropriate discounts that applied when determining the value market value of the transferred interest. 

With respect to the discount for lack of control, the Commissioner’s expert determined that no such discount was merited because, as the holder of an 88.99% limited partnership interest, the partnership agreement provided the holder with significant influence and control over the Streightoff Investments’ management.  The Estate’s expert, on the other hand, applied a 13.4% discount for lack of control based on the transferred interest being an assignee interest.  Because the Tax Court determined that the transferred interest was a limited partnership interest, it applied no discount for lack of control. 

With respect to the discount for lack of marketability, the Commissioner’s expert determined that an 18% discount was appropriate.  That determination was based on data from newer restricted stock studies and Streightoff Investments’ ability to make distributions, strong financial conditions and prospects, highly liquid assets, asset diversification, and right of first refusal.  The Estate’s expert, on the other hand, determined that a 27.5% discount for lack of marketability was appropriate based principally on older restricted stock studies (because of the longer expected holding period) and the transferred interest being an assignee interest.  Once again, because “[the Tax Court] concluded that the interest [the] decedent transferred was a limited partnership interest, the estate’s experts’ valuation [was] too high,” finding, instead, that the analysis by the Commissioner’s expert was reasonable.  Id. at 27.  As a result, the Commissioner prevailed on every issue.

III.           Conclusion

Estate of Streightoff is a recent memorandum decision from the Tax Court discussing interesting issues that might arise when a taxpayer’s estate plan involves the use of a closely held entity.  Experience suggests that the Commissioner sometimes focuses on closely held entities when examining a taxpayer’s gift or estate tax return.  That focus might arise from valuation issues inherent in closely held entities (e.g., the opinions of business valuation experts regarding the fair market value of an interest in a closely held entity often differ).  Estate of Streightoff demonstrates that point.

 

† This article is designed to provide information about the subject matter and has been prepared with the understanding that neither the author of this case summary nor Baker Botts L.L.P. is providing accounting, tax, or legal advice or is performing any legal, accounting, or other professional service.  If accounting, tax, or legal advice or other expert assistance is required, seek out the services of a competent professional person. 

* Benjamin A. Cohen-Kurzrock, J.D., C.P.A., is an associate at Baker Botts L.L.P. who focuses his practice on federal estate, gift, and income tax issues for high‑net‑worth clients. 

[i] The Tax Court determined that restrictions on an assignee interest’s information rights were immaterial in this case because Elizabeth was both general partner and trustee of the Living Trust.  Analogizing to the position taken in Kerr v. Comm’r, 113 T.C. 449, 467 (1999), the Tax Court also determined that restrictions on an assignee interest’s voting right “would have been of no practical significance.”  Id. at 20.  

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