FLP planning in the wake of recent taxpayer victories

Last March, Mirowski v. Commissioner, the U.S. Tax Court delivered a long-awaited victory to taxpayers and their appraisers when it found that a family limited partnership (FLP)—formed just days before the founder’s death—had legitimate, non-tax business purposes, sufficient to meet the exceptions under IRC Sec. 2036 and withstand an IRS attack.  Key to the court’s ruling: 1) no one expected the founder to die so quickly; 2) there was no provision to use the FLP assets to pay estate or gift tax liabilities (even though the latter were significant).  

Would the Astelford, Holman and Gross FLPs withstand a similar attack?  In recent weeks, we’ve also covered two gift tax cases, Holman v. Commissioner (May 2008) and Gross v. Commissioner (Sept. 2008), in which the formation and funding of FLPs withstood attacks by the IRS as indirect gifts.  In a third case, Astleford v. Commissioner (May 2008), the taxpayer convinced the court to adopt significant, multi-level discounts for lack of marketability and control in valuing the FLP.  Given the IRS’s sustained efforts to disable FLPs as tax-planning devices, however, the Service may likely attack these FLPs when their founders die, to recover the full value of the assets under Sec. 2036. 

What planning pointers can taxpayers glean from Mirowskito ensure more FLP victories in the estate context? That’s the very question Steve Akers of Dallas’ Bessemer Trust Co., NA, addresses in his current article, “Family Limited Partnership Planning Update in Light of Three Recent Judicial Decisions,” published in the Autumn 2008 Insights, by Willamette Management Associates:

Before getting carried away with the favorable taxpayer result in Mirowski, observe that Section 2036 involves a ‘smell test’ and Judge Chiechi (who wrote this judicial opinion) did not believe that the family was just forming the LLC to generate estate tax discounts.  The only way to rationalize the various FLP/LLC Section 2036 cases is to recognize that the courts apply a ‘smell test’ to avoid allowing a valuation discount in what the Tax Court perceives as abusive cases involving paper shuffling (often immediately before death) just to generate a valuation discount.

What helped Mirowski estate pass the “smell test,” Akers says, is the daughters’ credible testimony that their mother established the FLP for the significant non-tax reasons and not just to get the valuation discounts.   “Whether other judges will agree with that approach is yet to be seen.”  Cautious planners will continue to “be sensitive” about having the FLP founder serve as sole general partner or manager, Akers says, and they should pay attention to distributions—especially post-mortem payment of tax liabilities.  Finally, operating the FLP “in a way that is consistent with the stated nontax reasons” could be a deciding factor. 

Akers’ article is one of several in the current Insights, focusing on “Gift and Estate Tax and Intergenerational Wealth Transfers.” Archived articles will be posted to BVResearch™, which now boasts over 265 articles from Insights, 60 from Mercer Capital’s Value Matters, and more. 

CFA weighs in on the financial crisis and growing calls to rollback FAS 157

It’s no secret that many think that FAS 157 helped fan the flames of the current financial crisis (see: More blame for FAS 157 in current economic crisis?) while others assert that it confuses many valuation issues without sufficient guidance, especially on its seemingly counterintuitive valuation requirements. Indeed, just this week, in a letter to SEC chairman Christopher Cox, The American Bankers Association asked that the “SEC use its statutory authority to step in and override the guidance issued by FASB.” Another take: In a letter recently sent to Congressional leaders and the Securities and Exchange Commission (SEC), the CFA Institute Centre reinstated its position for an end to the calls for rolling back fair value reporting.  In brief, the letter notes that:

1) Ending fair value reporting will only serve to undermine the confidence of investors in our financial institutions and lead to a further crisis of confidence in our government and the regulatory bodies overseeing those institutions.
2) The process of stabilizing the global financial markets and reinvigorating liquidity starts with improving the transparency of financial institutions.
3) The causes of the massive asset write-downs we have observed have nothing to do with financial reporting, but everything to do with the need for effective stewardship.
4) Complaints about fair value arise largely in the context of their impact on capital adequacy. Rather than suspending fair value and thereby the transparency and relevance of financial information, perhaps the focus should instead be on flexibility in capital adequacy requirements in times of distress.

How will the financial crisis impact the BV profession?

It’s a question that we recently put to a host of industry experts and (as we expected) their hypotheses proved to be both compelling and insightful. For the full story, you’ll have to take a look at the full article in the next (November 2008) BVU. In the interim, below are a few of the comments offered by the BV experts that we queried:

—Some of the big picture issues resulting from the current financial problems impacting BV could be (1) a reassessment of mark to market and fair value accounting issues and the trickle down affect that could have on BV; and (2) closer scrutiny of the BV work product (If real estate appraisers were one of the scapegoats for the S&L crisis, BV could become one of the scapegoats in the current problem). More practically, a sustained economic slowdown could change the product mix of the BV industry….less transactional work and more litigation work. Quality appraisers will always be in demand. Bill Quackenbush, ASA, CBA (Advent Valuation Advisors, LLC)

—The problems today will be the basis of a lot of future litigation that will need valuation experts. Gilbert Matthews (Sutter Securities Incorporated)

—There will be more assignments as client look to readjust their financial position but fees will be harder to collect. We should also expect more regulation of our profession as stakeholders are more accountability. Jay Fishman, FASA (Financial Research Associates)

Statistical models can make all the difference

To refresh and refine your use of statistical models, regression analysis, and market event studies, be sure to tune into BVR’s next teleconference, “Compelling Statistical Evidence: Mining, Modeling, and Presenting Quantitative Financial Evidence to Juries,” featuring William Kennedy, Ph.D, CPA/ABV of St. Louis’ Anders Minkler & Diehl, LLP, and Jeffrey Dorman, Esq. with the Chicago office of law firm Freeborn & Peters, LLP.  The teleconference takes place Wednesday October 22, 2008; to register, click here. 

Just how important are statistical models? Just take a look at some recent cases where effective statistical analysis, including market event studies, became the “make or break” evidence, especially in cases concerning securities litigation and lost profit/economic damages:

• Expert’s market event study helps support loss causation claims and class action certification in large securities litigation; In re Flag Telecom Holdings, Ltd. Securities Litigation, (U.S. District Court, S.D.N.Y., 2007)
• Sophisticated event study shows efficient market and convinces court to certify class of litigants in a “fraud on the market” theory; In re Xcelera.com Securities Litigation (1st Cir., 2005)
• Delaware Chancery Court rejects lost profits computation based on an event study analysis that failed to consider all possible events that may have contributed to the loss; In Penn Mart Supermarkets, Inc. v. New Castle Shopping, LLC, (2005)
• Delaware Chancery Court favors "shared synergies" and actuarial analysis in the fair value appraisal of an insurance conglomerate’s merger; Highfields Capital, Ltd. v. AXA Financial, Inc. (2007)
• Federal court defines market efficiency, the five factors that prove it—and the statistical financial analysis that does (and does not) meet the burden of proof; In re Polymedica Corporation Securities Litigation (U.S. District Court, Mass., 2006)
• In context of shareholder seeking access to company books, Delaware Chancery Court approves unique statistical methodology for testing whether stock option backdating has occurred; Louisiana Municipal Police Employees' Retirement System v. Countrywide Financial Corp. (2007)
• Court reverses $1.45 billion jury verdict based on lack of "fraud-free" valuation of securities; Morgan Stanley & Co. Inc. v. Coleman Holdings Inc.(Fla. App., 2007)

The last case was—until its reversal for lack of reliable statistical evidence, the largest jury award for economic damages ever.  All of these case—especially in light of the securities and loss litigation that is certain to come out of the current economic spiral—demonstrate just how important it is for valuation analysts to present compelling and understandable statistical models to a judge or jury (and assist their attorneys in preparing the evidence for deposition and trial). Reminder: Copies of all cases are available at BVLaw™, and the case abstracts are available by subscription at BVLibrary™.)