Family Limited Partnerships Interests

A business valuation is often necessary to determine an interest in a family limited partnership. A family limited partnership (FLP) is a nontaxable entity that holds appreciable assets, and whose partners consist primarily of family members.

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Hypothetical scenarios that require an expert in business valuation:

– The owner of a company wishes to transfer a portion of his company to his children and has formed a FLP to accomplish this task. The owner wants to maintain control of the company, so he transfers a 10% minority interest in the FLP to each of his children. Since the interest to be valued is a minority, non-marketable interest, valuation discounts must be applied, which would considerably reduce the taxable value of the interests being transferred.

– A business owner has his family owned business in an FLP. He is currently the controlling, majority owner and his wife is a 5% interest minority owner. The business owner wishes to transfer the remaining 45% stake in the company to his daughter. Since the interest to be valued is a minority, non-marketable interest, valuation discounts must be applied, which would considerably reduce the taxable value of the interest being transferred.

Special considerations for Family Limited Partnership interest valuations:

When business owners transfer an interest in a family limited partnership to a family member, such a transfer will create a tax liability, as would gifting a business. The primary difference is that the entity being transferred is not the underlying assets of the FLP, but the FLP itself. Valuation reports that are used to determine the tax liability of the transfer need to thoroughly research the basic characteristics of the transferred interest in the FLP and specific provisions in the FLP agreement and state law.

A valuation report whose purpose is to determine the tax liability for a family limited partnership interest will generally require more research and analysis than a typical report. This is because these reports will often be reviewed by the IRS and, if the IRS believes the value of the transferred interest to have been understated, the valuation report may be challenged. In this case, the professional appraiser would defend the report and explain how the final value was determined using standard valuation approaches. Without engaging a qualified, independent appraiser to knowledgeably defend their work, involved parties may face excessive fines and penalties.

Special consideration should also be given to the valuation discounts which are typically applicable. In general, valuation discounts will reduce the taxable liability created by a transfer of a FLP interest; however, without thorough research and analysis, discounts are often prime targets for scrutiny by the IRS. Significant amounts of research have been published examining the valuation discounts that may be applicable to minority interests. However, the proper application of discounts requires an in-depth understanding of how the supporting research has been developed and how the special characteristics of the interest to be valued influences applicable discounts.