Contents

• Experts Duel Over Discounts in Minority Shareholder's Divorce
• No Legitimate Business Purpose for FLP Precludes Analysis of Discounts
• Court Allows Art Collector's Estate Only 5% Fractional Interest Discount
• Damages for Lost Customer Accounts is Net Value of Lost Profits, not Fair Value
• Fair Market Value Includes Only Reasonably Foreseeable Subsequent Events
• Bankruptcy Court Cannot Just 'Split the Difference' in Divergent Discount Rates
• New FLP Case: Taxpayer's First Asset Transfer Merits Discount, But Not Second

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ESOPs as a Liquidity Event

The credit crunch and recession that the United States has endured during the past 12 to 18 months has created a difficult environment for owners of small and middle-market companies to sell their businesses. Although signs of economic recovery are on the horizon, the M&A markets remain sluggish. Despite the current market conditions, Employee Stock Ownership Plans (ESOPs) remain a viable strategy for business owners who desire either a full or partial liquidity event. An ESOP is a qualified retirement plan that primarily invests in the stock of the employer company. Thus, an ESOP can be used by a business owner to "create" an internal buyer of company stock. In addition, ESOPs can create substantial tax benefits for both the corporation and selling shareholder.

As an ESOP-owned company, SC&H has the real world experience necessary to help our clients navigate the unique aspects of an ESOP. We rely on the specialized knowledge of our professionals to serve ESOP clients nationwide, assisting selling shareholders, plan sponsors and trustees in establishing and maintaining well designed ESOPs. Our services cover both the initial ESOP transaction as well as annual compliance issues and include all of the following:

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Valuations Insights, Fourth Quarter, 2009

New FLP Case: Taxpayer's First Asset Transfer Merits Discount, But Not Second

Estate of Miller v. Comm'r Internal Revenue, T.C. Memo 2009-119, 2009 WL 1472208 (U.S. Tax Ct.)

May 27, 2009

In this case the first FLP asset transfer successfully escapes the pull of IRC Sec. 2036, but the second does not.

Perpetuating the father's investment method.

The father of the Miller family researched and invested in marketable securities using a specific method of charting stocks for the 26 years following his retirement. When he died in 2000, Miller's stock portfolio was worth roughly $7.6 million.

Miller's 86 year-old widow decided to form an FLP with a portion of the assets. The stated purpose of the FLP was to "buy, sell, and trade in securities of any nature…" and to acquire similar assets and investments to further this goal. As general partner, the eldest son worked 40 hours per week for a monthly fee to manage the FLP securities according to his father's charting method.

About a year later, the widow fell and broke her hip. Within a month she was diagnosed with congestive heart failure, and in early May 2003, her son had her sign a letter transferring all of her remaining assets into the FLP. By the end of the month, she was dead and the FLP used some assets to pay her estate taxes. In 2004, her estate tax return valued the FLP assets at $2.59 million, after application of the 35% marketability discount. The IRS assessed over $500,000 in deficiencies, which the estate paid and then sued for a refund.

FLP has legitimate, non-tax purpose.

The IRS did not contest the 35% discount; instead, it argued that the full value of the FLP assets should be pulled back into the estate because the FLP served no legitimate and substantial, non-tax purpose.

The estate claimed that the FLP served the legitimate, non-tax business purposes of asset protection, management succession, centralized management, and continuation of the family's investment strategy. Of all these, the court focused on the family's investment strategy purpose, and was persuaded that Mr. Miller had passed his particular stock-charting method directly to his eldest son, who as general manager continued to monitor the stock market daily, actively discuss the FLP's trades with his family, and provide them with financial advice.

"[An FLP's] activities need not rise to the level of a ‘business'… The non-tax purpose behind formation of [the FLP] was to continue Mr. Miller's investment philosophy."  In addition, at the time of the first funding, the widow was in general good health, and she retained sufficient assets (over $1 million) outside of the FLP to pay for daily living expenses.

Second transfer was a different story.

The "driving force behind the May 2003 transfers was the precipitous decline in [the widow's] health," the court said. The second transfers were driven by the desire to reduce her taxable estate, as they "completely depleted" the widow's resources, including any funds to pay living her expenses or estate tax liabilities. Accordingly, the second transfer of assets did not qualify for the Sec. 2036(a) exception, the court held, and included their full, fair market value in the widow's estate, without any discount.

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