Two Taxpayer Victories Demonstrate Winning Facts
for Family Limited Partnerships
As textbook examples of how to form, fund and
operate a family limited partnership (FLP) - sufficient to value various assets
(including real estate, restricted holdings and publicly traded securities) at
substantial discounts for federal estate tax purposes - the Murphy and Black
cases make excellent reading for attorneys and financial advisors alike.
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Legitimate Business Purpose
The Murphy Oil
Corp. grew from a small family-owned business into a $2 billion international
conglomerate. During the 1990s, Mr. Murphy established an FLP (Murphy LP) funded
with $89 million in company stock plus bank and real estate holdings.
Importantly, this represented only half his net worth, and he never mingled his
personal assets with those of the FLP. Overall, the father retained a 95%
limited partnership interest in the FLP, with his two sons in charge of daily
For five years, the FLP traded assets, managed
employees, held regular meetings and prepared regular statements. It made only
two distributions, with appropriate adjustments to the partners' capital
accounts. After the father died suddenly in 2002, the IRS issued assessments of
$34 million stemming from alleged tax deficiencies, prompting a legal challenge
by the father's estate.
In Murphy v. U.S., 2009 WL 3366099 (W.D.
Ark.) the Court determined that the Murphy LP was created with the purposes of:
pooling and investing the family assets
according to the father's philosophy;
passing management responsibility onto the next
enabling the father to gift interests in the
FLP while the underlying assets stayed under central management;
educating the father's heirs about wealth
acquisition, management and preservation; and
protecting family assets from creditors,
divorce and dissipation by future generations.
Moreover, the Court found that the Murphy LP was an
active, ongoing entity that respected partnership formalities. Based on these
strong facts, the Court concluded the FLP was established for legitimate and
significant non-tax purposes, sufficient to exclude the value of its underlying
assets from the father's gross estate per IRC Sec. 2036(a)(1)(bona fide sale
exception for adequate consideration).
To value Mr. Murphy's 95% FLP interest, the Court
considered the parties' credentialed experts, who took the net asset values of
the underlying interests before applying Rule 144 and blockage discounts as well
as minority and marketability discounts. Their results diverged widely, but in
each instance the Court found the taxpayer's expert to be more credible, largely
because he considered specific qualitative factors, including the FLP's
substantial cash balance and the relative holding period, risk, distribution
policy, and transfer restrictions of its assets. After adopting all the estate's
discounts, the Court found the fair market value of the 95% Murphy LP interest
to be $74.5 million and ordered a complete tax refund.
Another Winning Story
Samuel Black worked
his way up from peddling newspapers on the street to senior vice president and
second largest shareholder of the Erie Indemnity Co., a national insurance
company. To pool, protect and prolong his family's wealth, Mr. Black formed an
FLP in 1993, retaining a 1% general partnership interest with LP interests
dispersed among his son and his grandsons' trusts, with substantial
restrictions. He funded the FLP with Erie stock worth $80 million, which
increased to $318 million over the next seven years. The partnership distributed
92% of Erie dividends, with appropriate adjustments to the partners' accounts,
and the Blacks never dipped into the assets for their own expenses.
Mr. Black died in 2001, and Mrs. Black followed
soon after. The IRS assessed deficiencies totaling over $83 million on their
estate tax returns. The parties resolved all the valuation issues prior to
trial, leaving only the Sec. 2036(a) issue, i.e., whether the stock transfers
were bona fide, for a legitimate non-tax purpose. The taxpayer claimed the
following in support:
The FLP's net asset value increased
dramatically through active investment according to Mr. Black's "buy and
The transfer restrictions successfully
prevented Mr. Black's son from dissipating his assets in divorce and his
grandsons from reaching their stock, even when their trusts terminated.
The Black family's consolidated position
allowed it to maintain a seat on the Erie board.
The taxpayer also cited Estate of Schutt v.
Comm'r (T.C. Memo 2005), in which the Tax Court validated an FLP for its
"unique circumstances" – primarily its pooling of assets according to the
founder's investment philosophy, to preserve them against claims from creditors,
divorcing spouses, and irresponsible heirs.
The IRS tried to discount the relevance of
Schutt by claiming that Black's concerns for his Erie holdings was either
"ill-founded" or insignificant. The Court was persuaded by the precedent,
however, and the similar "unique" facts of this case. Moreover, the FLP
respected partnership formalities, including appropriate adjustments for
contributions and distributions.
Accordingly, the court held that the fair market
value of Mr. Black's FLP interest, rather than the fair market value of the
underlying Erie stock, was includable in his gross estate. ■