Latest FLP disaster includes pulling discounts 'out of the air'

“It is a truth universally acknowledged that a recently widowed woman in possession of a good fortune must be in want of an estate planner.” So begins the latest Tax Court memorandum opinion (by Judge Holmes) to address the effectiveness of family limited partnerships (FLPs) as an estate planning devices. Estate of Hurford (Dec. 12, 2008) follows the story of the devoted widow Hurford, whose husband died quite suddenly, leaving her to quickly learn estate management. Her burden was accelerated when she was suddenly stricken with cancer. “Two attorneys vied for her attention and she chose [one],” the court said. “She lost her life to the cancer. We must now decide how much of her estate will be lost to taxes.”

Who can resist such an opening? Well, for one, the court’s opinion is 85 pages long. And two, not all bodes well for the Hurford estate—or its attorney, whom the court criticized for many errors, including sloppy drafting of key documents and making “egregiously false” statements on tax returns. Notably, the attorney also declined to retain independent appraisals of the numerous interests at stake—three FLPs funded with a private annuity—bragging to the Hurford heirs that he had “experience obtaining 50 percent discounts in settlements on estates with the IRS.” However, the method he used to pick the discount factors was “haphazard,” according to the court, ranging from 25% to 42%, with no clear basis for the percentages.

The end of the story: At trial, the estate offered two independent experts, “to clean up some of the problems.” Nevertheless, even their testimony—that the discount factors were within acceptable limits—could not save the mess that bad advice and poor execution had made of the widow Hurford’s estate. Suffice to say that under IRC Secs. 2035, 2036, and 2038, the court recovered all of the property that the attorney tried to transfer out of the estate via the FLPs.  It further found that the attorney “conjured the partnership discounts out of the air,” and that a “careful attorney” would have had the assets re-appraised at the time of funding. Finally, the court offered a long list of factors by which to assess the non-tax purpose of a proposed FLP, including:

1. Adherence to partnership formalities;
2. The taxpayer’s dependence on distributions;
3. Whether the taxpayer commingled personal funds with partnership funds;
4. The taxpayer’s old age or poor health when forming the FLP; and
5. Whether the FLP functioned as a business enterprise or otherwise engaged in any meaningful economic activity. Considering the entities in this case, the court found that they existed only to satisfy the Hurfords’ “drive for a discount.”

Look for a complete case abstract of Estate of Hurford in the February 2009 Business Valuation Update™. At the time, the court’s opinion will also be posted to BVLaw™. (Note: Special thanks to Owen Fiore of FioreWealthPlanningConsulting in Kooskia, Idaho for alerting us to the decision. Fiore will soon post his own assessment of Hurford at his website.)

Untying the knot—highlights from BVR’s Divorce Workshop with Carole Gailor, Esq.

Today at 10 am PST/1 pm EST, BVR will host a special 150 minute (3 CPE) broadcast of highlights from our 2 day Divorce Seminar held this past September.  BVR’s all-star cast of distinguished business appraisers, lawyers, and judges—including Jay Fishman, John Johnson, Chris Mercer, Ashok Abott, Frank Louis, Carole Gailor, and Hon. Jacqueline Silberman—met to discuss the most onerous topics in martial dissolution cases, such as Court Appointed Experts, Subsequent Events, Double Dipping, and Judicial Examination of BV reports.

This unique teleconference will include live commentary from Carole Gailor, a Fellow of the American Academy of Matrimonial Lawyers (Gailor, Wallis & Hunt, PLLC), whose perspective is highly valuable to anyone working with divorce-related valuation.  Carole will be joined by moderator Stuart Weiss (Stuart Weiss Valuations Inc.) to answer listeners’ questions live.

Don’t miss this special year-end offer: A star-studded list of experts, live commentary from a leading divorce attorney, and 3 CPE credits for the price of 2.  Listeners will also receive must-have ancillary materials including court case abstracts and articles. Click here to register.

IRS continues outreach efforts with BV while gearing up for 409A oversight

“I want to outreach with you and my colleagues want to outreach with you,” Michael Gregory, an IRS Territory Engineer, told over 1400 attendees at the recent AICPA/ASA National Business Valuation conference in Las Vegas. (Important: Gregory offered his own opinions, not those of the IRS.) To fulfill these efforts, the IRS is currently beefing up its team of engineers and appraisers, adding two territory managers in the West and two more in the East. The managers network every month, according to Gregory, talking about “what we can do to strengthen our partnerships with the private sector.” If they’re not doing their job, then “you need to come and tell us that we’re not.”

What about appraisers who may not be doing their jobs? The IRS continues to use the penalty provisions in IRC Sec. 6695A as a key enforcement tool to curb appraisal abuses. So far, the Service has asserted 146 penalties in the estate and gift arena, charitable deductions, conservation easements, and pension fund (ESOP). Review of Sec. 409A is another area where the IRS is currently increasing its oversight. Gregory chairs the team on 409A appraisals, who will be “off and running” in the spring of 2009. (At the meeting, Gregory suggested that appraisers refer to the AICPA’s practice guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation.)

In his AICPA/ASA presentation, Gregory also offered suggestions on how to avoid the top 22 valuation-related missteps—including the valuator’s use of aged data, improper discount and cap rates, and inappropriate discounts for lack of marketability and minority interests. Overall, Gregory suggests making sure that your valuation conclusion passes the “common sense” test. Ask yourself: Would I be willing to pay that amount if I had the money to buy this company?” For a full accounting of the most common appraisal errors according to the IRS, see the article in the January 2009 Business Valuation Update™.

The demise of the IPO market?

In each of the years 1991 through and including 1997, there were more than 150 small IPOs (those that raised less than $25 million), and three years with more than 300 small IPOs. In each of the years 2000 to 2008, there were never more than 25 small IPOs. What happened to the IPO market? Just last month, Grant Thornton released a report titled Why are IPOs in the ICU?, authored by David Weild and Edward Kim. In it, the authors discuss what they believe are some of the main causes of the drastic reduction in the IPO market since the burst of the investment bubble in 2000-2001. They also conclude that, “The market for underwritten IPOs, given its current structure, is closed to most (80 percent) of the companies that need it." 

The Weild/Kim report reviews the history of the IPO market, the reasons for the current IPO crisis, and their “ideas for a new, opt-in stock market capable of reinvigorating the U.S. IPO market.” Without the investment in new and developing companies, there is little financing available to develop new and risky ideas – like the $8 million IPO for Intel back in 1971. Will the U.S. lose its competitive advantage? Weild/Kim answer this question and more. To read their full report, click here. You can also learn more about specific IPOs and how to use pre-IPO trades to develop a lack of marketability discount, by clicking on the “Read Articles” link at the Valuation Advisor’s Lack of Marketability Discount Study™ introduction page.

Pratt’s Stats® keeps giving you more

Peter Schiff may have been two years ahead of his time, but few now doubt the economy is severely recessed. In a year when companies are cutting back and giving you less for your hard-earned dollars, Pratt’s Stats rejects the cost-cutting norm and, in doing so, gives you even more bang for your buck. Not only does Pratt’s Stats continue to be the premier private transaction database for the valuation professional, it has received a data injection sizable enough to make even Jose Conseco blush. In 2008, Pratt’s Stats added a whopping 1,933 new deals to the database—629 more transactions than last year’s addition of 1,304 deals!

Note also that this hefty addition of transactions comes during a year when M&A and buying activity took a nosedive. The largest increases came from restaurants (+314 new deals), gasoline service stations (+72), business services (+60), software (+57), and grocery stores (+51). At up to 88 data points per transaction and 12,390+ total private deals, Pratt’s Stats empirical data provide your catalyst for arriving at an accurate, supportable valuation. These transactions are but finger strokes away—visit BVMarketData.com to take advantage of this resource.