By: Mark Rhea, J.D.- Senior Assistant Accountant

Valuation discounts are not very hard to understand. I’ll start by asking a simple question, if you had an opportunity to purchase one share of ABC , Inc., which share would you pay more for – the share that had no restrictions on its resale or the share with restrictions? The natural answer is that you would pay less for the shares that had  restrictions on their resale. This raises the question of how much less does the share with restrictions on its resale command. Whatever that amount is, that is a valuation discount, specifically a discount for lack of marketability or lack of control – depending upon the precise fact pattern of the situation.

Since in the issuing of Rev. Rul. 59-60 which provided the foundation for guidance for valuation discounts almost 60 years ago, valuation discounts have been applied to shares of all kinds of business entities including family entities such as family limited partnerships. However, recently under the prior administration the IRS did not like the fact that family limited partnerships were able to use valuation discounts for gift and estate tax purposes. Many family entities have agreements and guidelines that contain restrictions for who can own an interest in the entity and how it can be sold. The IRS believed that using these restrictions as justification for a lack of marketability was primarily a way to dodge taxes. Their solution through proposed Sec. 2704 regulations was to eliminate the lack of marketability discount for family entities for gift and estate tax purposes.

Thankfully, through the recent actions of the U.S. Treasury under the current administration, these proposed regulations by the prior administration are not going anywhere and family entities can still use lack of marketability discounts when valuing an interest in a family entity for gift and estate tax purposes.

However,  the restrictions that are placed in the operating agreement or guidelines of a family entity regarding who can own it and who can control it have non-tax benefits. In watching “The Godfather” you can see the benefits of these kinds of restrictions demonstrated in the actions of the Corleone family. Don’t want your abusive and betraying son-in-law Carlo Rizzi from doing anything important in the family business? Put restrictions on who can control or own portions of the family business. Afraid your feeble-minded son, Fredo could assume any control over the important aspects of the family business? Place restrictions on who can control decision-making by limiting it to a small number of trusted family members. Do you know that your son, Michael has a great plan to keep the family business and its wealth going for years to come? Restrictions on who is in charge can help with ensuring smart wealth management and transfers of wealth in the future.

Regardless of how many of the these restrictions are in place for a family limited partnerships, without communication and an understanding of the restrictions regarding the roles all family members play in the partnership, trouble may ensue. Just as Vito Corleone called a meeting of the all of the families in New York and beyond after Sonny met his demise on the causeway, it is important for families to keep the lines of communication open and meet on a regular basis to discuss issues of concern. Not only is regular communication important, but also the family members must understand issues facing the partnership and their rights and roles that they play in it. After all, what good is a meeting if no one understands what’s happening?

At Holbrook & Manter, CPAs we want to help you succeed and address issues that your family limited partnership has and guide it in a prosperous direction. Inspiration for the blog was not only from Francis Ford Coppola’s “The Godfather,” but also from the article “Nontax Concerns Raise Need for Family-Entity Planning” by Jim Brennan and Daisy Medici. See Brennan, J. and Medici, D. (2017). Nontax concerns raise need for family-entity planning. Retrieved December 19^th, 2017, from RIA Checkpoint.