TAX COURT DETERMINES IF INTEREST INCLUDIBLE IN ESTATE WAS PARTNERSHIP OR ASSIGNEE INTEREST

Posted by Kim Chen on November 11th, 2018

Estate of Streightoff, TC Memo 2018-178
The Tax Court has determined the type and value of an interest that a taxpayer transferred during his lifetime to a revocable trust that had to be included in his estate — a limited partnership interest or an assignee interest in the partnership interest.
Background. Generally, State law determines the property interest that has been transferred for Federal estate tax purposes. (McCord v. Comm., (2003), 120 TC 358, 370 rev’d and remanded on other grounds, (CA5 2006) 98 AFTR 2d 2006-6147) Texas Revised Limited Partnership Act (TRLPA) — as in effect for the relevant period — provided that a partnership interest is personal property and is assignable, in whole or in part, unless the partnership agreement provides otherwise. (Tex. Rev. Civ. Stat. Ann. art. 6132a-1, secs. 7.01 and 7.02(a)(1)).
An assignee of a partnership interest is entitled to receive, to the extent assigned, allocations of income, gain, loss, deduction, credit, or similar items, and to receive distributions to which the assignor is entitled, but an assignment does not entitle the assignee “to become, or to exercise rights or powers of, a partner”. (Tex. Rev. Civ. Stat. Ann. art. 6132a-1, sec. 7.02(a)(2) and (3)) The assignee may become a limited partner, with all rights and powers of a limited partner under a partnership agreement, in the manner that the partnership agreement provides or if all partners consent.
While the Tax Court takes note of State law, the Federal tax effect of a particular transaction is governed by the substance of the transaction rather than its form. Substance over form is a judicial doctrine in which a court looks to the objective economic realities of a transaction rather than to the particular form the parties employed. (Frank Lyon Co. v. U.S., (1978, Sup Ct) 41 AFTR 2d 78-1142) In essence, the formalisms of a transaction, which often exist solely to alter the parties’ tax liabilities, are disregarded, and the substance of the transaction is examined in order to determine its true nature. In applying the doctrine, courts may consider whether the form of the transaction had any purpose beyond reducing taxes.
The doctrine that the substance of a transaction will prevail over its form has been applied in Federal estate and gift tax cases. In particular, the courts have indicated a willingness to look beyond the formalities of intrafamily partnership transfers to determine what, in substance, was transferred. (Kerr v. Comm., (1999) 113 TC 449, aff’d, (CA5 2002) 89 AFTR 2d 2002-2838).
Facts. On Oct. 1, 2008, Frank D. Streightoff (decedent) formed Streightoff Investments, LP (Streightoff Investments), as a limited partnership under the provisions of the TRLPA, Tex. Rev. Civ. Stat. Ann. art. 6132a-1 (West 2008). Streightoff Investments did not hold partnership meetings or have votes.
Streightoff Investments’ assets including marketable equity securities, municipal bonds, mutual fund investments, other investments, and cash. Decedent, his daughters, his sons, and his former daughter-in-law were Streightoff Investments’ original limited partners under the partnership agreement. The limited partners other than decedent received their limited partnership interests as gifts. Decedent reported these gifts on a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, filed for 2009.
Streightoff Management, LLC (Streightoff Management), was Streightoff Investments’ sole general partner. The decedent’s daughter, Ms. Streightoff, was manager of Streightoff Management. Under the partnership agreement, limited partners could remove the general partner by written agreement of limited partners owning 75% or more of the partnership interests held by all limited partners. If the partnership terminated by reason of the general partner’s removal, then 75% of the limited partners could reconstitute the partnership and elect a successor general partner. Limited partners owning at least 75% of the ownership percentage in the partnership could approve the admission of additional limited partners to the partnership.
Under the partnership agreement, a limited partner could not sell or assign an interest in Streightoff Investments without obtaining the written approval of the general partner (which was not to be unreasonably withheld). Any partner who assigned his interest remained liable to the partnership for promised contributions or excessive distributions unless and until the assignee was admitted as a substituted limited partner. The general partner could elect to treat an assignee as a substituted limited partner in the place of the assignor. An assignor was deemed to continue to hold the assigned interest for the purposes of any vote taken by limited partners under the partnership agreement until the assignee was admitted as a substituted limited partner.
All transfers of interests in Streightoff Investments were subject to limitations. The partnership agreement provided that a transferee of an interest in Streightoff Investments could become a substituted limited partner upon satisfaction of certain conditions, including that the general partner consent, that the interest was acquired by means of a permitted transfer, and that the transferee become a party to the partnership agreement as a limited partner and execute such documents and instruments as the general partner may request to confirm that the transferee agreed to be bound by the terms and conditions of the partnership agreement.
Under the partnership agreement, persons who acquired interests in Streightoff Investments but who were not admitted as substituted limited partners to the partnership (“unadmitted assignees”) were entitled only to allocations and distributions in respect of their acquired interests. Unadmitted assignees had no right to any information or accounting of the affairs of the partnership, were not entitled to inspect the books or records of the partnership, and did not have any of the rights of a general or limited partner under TRLPA.
On Oct. 1, 2008, decedent executed an agreement entitled “Assignment of Interest” (agreement), which designated decedent as “assignor” and the revocable trust as “assignee”. The agreement provided that decedent made an “assignment” of all of his limited partnership interest in Streightoff Investments. It provided that decedent transferred “[his] interest in the above described premises, together with all and singular the rights and appurtenances thereto in anywise belonging, unto the said Assignee, its beneficiaries and assigns forever” and that he bound himself and “[his] heirs, executors, and administrators to …provide any further documentation or execute any additional legal instruments necessary to provide the assignee all the rights the Assignor may have had in the property”. The agreement provided that the revocable trust “by signing this Assignment of Interest, hereby agrees to abide by all the terms and provisions in that certain Limited Partnership Agreement of Streightoff Investments, LP, dated effective Oct. 1, 2008”.
On Aug. 9, 2012, the estate filed a Form 706 (United States Estate (and Generation-Skipping Transfer) Tax Return) (i.e., estate tax return). Mr. Streightoff’s daughter as decedent’s executor elected to use the alternate valuation date of Nov. 6, 2011, to value the estate’s assets. On the estate tax return the estate reported a gross estate less the exclusion of $5,051,299
On Schedule G the estate described the property transferred to the revocable trust as an assignee interest in an 88.99% limited partnership interest. The estate reported the value of the transferred interest as $4,588,000 as of the alternate valuation date. The estate’s valuation of the transferred interest calculated 88.99% of the partnership’s net asset value (NAV) on the alternate valuation date (i.e., $7,307,951) and discounted that value by 37.2%. In a supplemental statement the estate indicated that it claimed discounts for lack of marketability, lack of control, and lack of liquidity.
On Jan. 9, 2015, IRS sent a notice of deficiency, determining a deficiency of $491,750. The notice included a Form 1273 (Report of Estate Tax Examination Changes, a Form 6180, Line Adjustment–Estate Tax), and two Forms 886-A (Explanation of Items). The Form 6180 showed an adjustment in value to items reported on Schedule G of $1,405,000. The attached Forms 886-A stated IRSS’s determination that the corrected value of decedent’s interest in Streightoff Investments on the alternate valuation date was $5,993,000.
The taxpayer’s estate sought relief in the Tax Court.
In evaluating the value of the interest the decedent transferred, IRS’s expert determined that decedent’s limited partnership interest held considerable influence and control over the management of Streightoff Investments because of specific provisions in the partnership agreement. The expert noted that under the partnership agreement limited partners with a 75% interest held the power to remove general partners, and a general partner’s removal terminated the partnership. The expert stated that a prospective purchaser of decedent’s 88.99% limited partnership interest would pay more for the degree of control embodied in the interest, including the ability to unilaterally terminate the partnership if he did not agree with the management of the general partner. The expert concluded that no discount for lack of control should be applied to the interest.
The expert for the decedent’s estate assumed that the interest to be valued was an assignee interest in decedent’s limited partnership interest and that a hypothetical buyer would pay less for an interest that did not give the holder access to or control over the underlying assets of the partnership. The expert acknowledged that the partnership agreement provided limited partners with the right to vote on decisions affecting partnership management, including the removal of the general partner and termination of the partnership, but determined that the interest at issue would provide none of these control benefits because it was an assignee interest. The expert concluded that a 13.4% discount for lack of control should be applied in valuing the interest.
Parties’ positions. The estate contended that the agreement created an assignee interest in decedent’s limited partnership interest under Texas State law and the partnership agreement. It contended that it properly valued and reported decedent’s interest in the revocable trust correctly as an assignee interest on Schedule G of its tax return
On the other hand, IRS contended that the agreement did not create an assignee interest held by the revocable trust. IRS argued that decedent transferred his 88.99% limited partnership interest to the revocable trust and the value to be included in the value of the gross estate should be that of a limited partnership interest.
Court’s conclusion. The Tax Court found that under the facts and circumstances of this case, there was no difference in substance between the transfer of a limited partnership interest in Streightoff Investments and the transfer of an assignee interest in that limited partnership interest. Accordingly, as a matter of both form and substance, the interest to be valued for estate tax purposes was an 88.99% limited partnership interest in Streightoff Investments.
The Tax Court concluded that the form of the agreement established that decedent transferred to the revocable trust a limited partnership interest and not an assignee interest. The economic realities underlying the transfer of decedent’s interest also support the Court’s conclusion that the transferred interest should be treated as a limited partnership interest for Federal estate tax purposes. Regardless of whether an assignee or a limited partnership interest had been transferred, there would have been no substantial difference before and after the transfer to the revocable trust.
Under Streightoff Investments’ partnership agreement only the general partner had the right to direct the partnership’s business; neither limited partners nor assignees had managerial rights. The partnership agreement provided that assignees had no rights to any information regarding the business of the partnership or to inspection of the books or records of the partnership. However, this distinction made no difference in this case because the decedent’s daughter, Ms. Streightoff, was both a partner entitled to information regarding Streightoff Investments and the trustee of the revocable trust.
The partnership agreement provided that an unadmitted assignee did not have the right to vote as a limited partner. The Court noted that in Kerr, it had found that the only real difference between the rights of a limited partner and those of an assignee was the right to vote on partnership matters, and it had concluded that this difference was not significant. The Tax Court held that under such circumstances the transferred interest should be valued as a limited partnership interest rather than as an assignee interest.
Here, the Tax Court concluded similarly that whether the revocable trust held the voting rights associated with a limited partnership interest would have been of no practical significance. There were no votes by limited partners following the execution of the agreement. In addition, during his life decedent held the power to revoke the transfer to the revocable trust. If he had revoked the transfer, he would have held all the rights of a limited partner in Streightoff Investments, including the right to vote on partnership matters. Also, Streightoff Management as the general partner could have treated the holder of an assignee interest as a substitute limited partner.
As the Tax Court had determined that the interest transferred was an 88.99% limited partnership interest, it found that the interest did not lack control. Accordingly, there was no discount for lack of control.
However, the Court agreed with the estate’s experts that there should be a discount for the lack of marketability. Although it found that the estate’s experts’ valuation was too high because it assumed an assigned interest, the Court concluded that the interest should be valued using an 18% discount rate for lack of marketability.

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