UNITED STATES COURT OF APPEALS
For the Fifth Circuit
No. 00-60903
BAINE P. KERR; MILDRED C. KERR,
Petitioners-Appellees-Cross-Appellants,
VERSUS
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant-Cross-Appellee.
Appeal from the Decision
of the United States Tax Court
June 10, 2002
Before DUHÉ, BARKSDALE, and DENNIS, Circuit Judges.
DUHÉ, Circuit Judge:
Today we consider the method for evaluating for gift tax
purposes interests in a closely held family partnership. In
valuing an interest in a closely-held partnership, a discount for
lack of liquidity or marketability which would be generally
appropriate may be inappropriate if the valuation is to determine
tax owing on a gift of such interest. In establishing the
valuation for gift tax purposes, the Internal Revenue Code
disregards certain “applicable restrictions” on liquidation in a
partnership agreement if the gift is made to a family member.
I.R.C. § 2704(b).
In this case involving intra-family gifts of partnership
interests, the taxpayers challenge noticed gift tax deficiencies
based on the Commissioner’s position that Code § 2704(b) barred
them from applying a marketability discount to the values of the
interests they transferred. The Tax Court ruled summarily for the
taxpayers, holding that the special rule in § 2704(b) did not bar
their marketability discounts.
The Commissioner now appeals the Tax Court’s decision, arguing
that certain partnership agreement restrictions were “applicable
restrictions” on liquidation within the meaning of § 2704(b) and
should be disregarded, thus precluding a marketability discount in
valuing the gifts. Taxpayers cross appeal the court’s
determination that certain transferred interests should be
considered partnership interests. Because the undisputed facts
lead us to conclude that the restrictions in the partnership
agreements were not “applicable restrictions” within the meaning of
§ 2704(b), we affirm.
I. BACKGROUND
To make gifts to their children, Baine P. Kerr and Mildred C.
Kerr (“taxpayers”) created two family limited partnerships in 1993,
the Kerr Family Limited Partnership (KFLP) and Kerr Interests, Ltd.
(KIL), pursuant to the Texas Revised Limited Partnership Act.1
1
See Tex. Rev. Civ. Stat. Ann. art. 6132a-1 (Vernon Supp.
2002).
2
Taxpayers made capital contributions to KFLP and KIL. The
interests were allocated so that in KFLP, taxpayers and their
children were general partners; taxpayers were also Class A and
Class B limited partners.2 In KIL, KFLP was the general partner;
taxpayers were Class A limited partners; and KFLP, taxpayers, and
their children were Class B limited partners.
In June 1994 taxpayers transferred Class A limited partnership
interests in KFLP and KIL to the University of Texas (UT). In
December 1994, the KIL partnership agreement was amended to admit
UT as a Class A limited partner.
A. The Transfers at Issue.
In December 1994 and December 1995, taxpayers each donated
Class B partnership interests in KIL to their children. These are
the first transfers at issue.
In December 1994, taxpayers each created an irrevocable
Grantor Retained Annuity Trust (GRAT) to which each grantor
transferred assets retaining a right to receive a fixed annuity for
a term of years. Each taxpayer was the sole trustee of his GRAT,
and their children and grandchildren were the beneficiaries of the
remainder interests via generation-skipping transfer trusts, called
the Kerr Issue GST Trusts. Each taxpayer contributed a Class B
interest in KFLP to his GRAT. These transfers by taxpayers of
2
In both KFLP and KIL, Class A limited partners are entitled
to a guaranteed annual return. General partners and Class B limited
partners are entitled to any profits remaining after distributions
to the Class A interests.
3
interests in KFLP to their GRATs are the second transfers at issue.
In exchange for the contribution of a Class B interest in KFLP
to his GRAT, each taxpayer received an annuity with a present value
of 95% of the value of that interest. The annuity payments were due
in two installments: the first on the day after the creation of
the GRATs, and the second a year and a day later. Neither of the
annuity payments was made. Instead, on each payment date, the
trustees executed demand notes to taxpayers in the amounts of the
annuity payments then due.
A year and a day after their creation, the GRATs terminated.
The remaining assets and liabilities (including the demand notes)
passed to the Kerr Issue GST Trusts. In February 1998, taxpayers
forgave the demand notes, then a liability of the Kerr Issue GST
Trusts, subject to the condition that those trusts pay the
resulting gift taxes.
B. Taxpayers’ valuation.
On their 1994 and 1995 gift tax returns, taxpayers reported
all the transfers at issue. Taxpayers reported valuations arrived
at by applying marketability discounts reflecting the partnership
agreements’ restrictions on liquidation. Further, they considered
the KFLP interests transferred to the GRATs to be only assignee
interests, not veritable partnership interests to which § 2704(b)
might apply.3 Thus in valuing all those interests to determine tax
3
Taxpayers originally took this position with respect to all
the transfers at issue, conceding later that the transfers to their
4
liability, taxpayers ignored § 2704(b) and applied marketability
discounts.
C. The Commissioner’s valuation.
The Commissioner’s notice of deficiency asserted that
taxpayers’ valuations of the transferred interests were
understated. The Commissioner contended that both partnership
agreements’ restrictions on the right to liquidate constituted
“applicable restrictions” within the meaning of Code § 2704(b). An
“applicable restriction” on liquidation in a partnership agreement,
to the extent that it is more restrictive than state partnership
law, is disregarded under Code § 2704(b) in valuing the transferred
interests. The Commissioner also contended that the KFLP interests
assigned to the GRATs were equally subject to § 2704(b) because in
truth they were partnership interests.
D. The Tax Court Proceedings.
Taxpayers petitioned for redetermination in Tax Court. They
moved for partial summary judgment, asserting that the special
valuation rules of § 2704(b) were not applicable in valuing the
KFLP interests transferred to the GRATs because those interests
were assignee interests, not limited partnership interests at all.
Further, even if the transferred interests were limited partnership
interests, taxpayers contend that the restrictions in both
partnership agreements were not “applicable restrictions” under §
children were gifts of actual partnership interests.
5
2704(b). Thus § 2704(b), which might otherwise require
restrictions on liquidation to be disregarded for valuation
purposes, would not bar taxpayers’ use of marketability discounts.
The Tax Court ruled summarily for taxpayers. The Tax Court
actually rejected taxpayers’ argument about assignment, finding
that the interests transferred to the GRATs indeed were partnership
interests. The Court nevertheless held that the special valuation
rule in § 2704(b) did not apply to any of the interests taxpayers
transferred, because the partnership agreement restrictions are not
“applicable restrictions.” Because those restrictions were not
disregarded, the taxpayers were allowed their marketability
discounts off the values of the transferred interests. After that
partial summary judgment, the parties stipulated the taxes that
would be owing under the Tax Court’s ruling, reserving their right
to appeal the issues determined by the court.
The Commissioner appeals the determination that the
restrictions are not applicable restrictions, and taxpayers cross-
appeal on their alternative argument that the transferred KFLP
interests are only assignee interests.
II. ANALYSIS
A. The Commissioner’s Appeal: Applicable Restrictions or Not?
We first address the question whether the restrictions in the
partnership agreements are “applicable restrictions” to be
disregarded in valuing the transferred interests. We review de
novo a valuation question turning on a pure question of law. See
6
Adams v. United States, 218 F.3d 383, 386 (5th Cir. 2000). Because
the two partnership agreements are identical in all material
respects, this question affects all the transfers at issue, those
of interests in KIL to the children and KFLP to the GRATs.
The restrictions at issue are in § 9.02 and § 10.01 of the
partnership agreements. Section 10.01 provides that the
partnerships will dissolve and liquidate on the earlier of
December 31, 2043, by agreement of all the partners, or on the
occurrence of certain narrowly defined acts of dissolution.
Section 9.02 states that no limited partner shall have the right to
withdraw from the partnership before it dissolves and liquidates,
and also provides a put right for Class B limited partners.
The three defining features of an “applicable restriction”
pertinent to this appeal are that it a) effectively limits the
ability of the partnership to liquidate, b) lapses or can be
removed by the family after the transfer, and c) is more
restrictive than State law. I.R.C. § 2704(b)(2)(A), (2)(B), &
(3)(B); Treas. Reg. § 25.2704-2(b).4
4
Section 2704(b)’s special valuation rule provides as follows:
(1) In general. – For purposes of this subtitle, if –
(A) there is a transfer of an interest in a
corporation or partnership to (or for the benefit
of) a member of the transferor’s family, and
(B) the transferor and members of the
transferor’s family hold, immediately before the
transfer, control of the entity,
7
Because all three features listed above are required, the
absence of any one of them is dispositive. We first address the
question whether the restrictions lapse or can be removed by the
family after the transfer. Since lapsing is not a consideration,
the only issue under § 2704((b)(2)(B) is removability. The Tax
any applicable restriction shall be disregarded in
determining the value of the transferred interest.
(2) Applicable restriction. – For purposes of this
subsection, the term “applicable restriction” means any
restriction –
(A) which effectively limits the ability of the
corporation or partnership to liquidate, and
(B) with respect to which either of the following
applies:
(i) The restriction lapses, in whole or in
part, after the transfer referred to (1).
(ii) The transferor or any member of the
transferor’s family, either alone or
collectively, has the right after such
transfer to remove, in whole or in part, the
restriction.
(3) Exceptions. – The term “applicable restriction”
shall not include –
...
(B) any restriction imposed, or required to be
imposed, by any Federal or State law.
The gift tax regulations, provide that an applicable restriction
is a restriction on “the ability to liquidate the entity (in whole
or in part) that is more restrictive than the limitations that
would apply under the State law generally applicable to the entity
in the absence of the restriction.” 26 C.F.R. § 25.2704-2(b).
8
Court did not reach this issue.5 When reviewing an order granting
summary judgment, this Court is not limited to the trial court’s
conclusion, but can affirm a trial court’s judgment on any ground
supported by the summary judgment record. Cabrol v. Town of
Youngsville, 106 F.3d 101, 105 (5th Cir. 1977); see also Hoyt R.
Matise Co. v. Zurn, 754 F.2d 560, 565 n.5. (5th Cir. 1985) (applying
similar rule for judgment entered in a bench trial).
The Commissioner argues that the restrictions in the
agreements were removable by the family, because there is evidence
that UT, the only non-family partner,6 would not oppose their
removal if proposed by the Kerr family.7 The parties hve stipulated
that UT would convert its interests into cash as soon as possible,
so long as it believed the transaction to be in its best interest
and that it would receive fair market value for its interest. The
5
It found that the restrictions on liquidation (§ 10.01) were
not more restrictive than State law and that the restrictions on
withdrawal of a limited partner (§ 9.02) are not “restrictions on
liquidation.”
6
The parties acknowledge that UT received a partnership
interest in both partnerships. The documents referenced in the
briefs are an assignment by taxpayers of Class A limited
partnership interests in KIL and KFLP to UT, and an amendment to
the KIL partnership agreement admitting UT as a limited partner.
Exs. 5-J and 9-J. We do not concern ourselves with questions not
raised in this appeal, such as whether the assignment conferred
partner status on UT in KFLP.
7
These partnership agreements may be modified or waived “only
by a writing signed by the party to be charged with such
modification . . . or waiver.” Partnership Agreements § 11.08. No
one has questioned whether UT is “charged with” modification or
waiver of the restrictions in the partnership agreements.
9
Commissioner argues that, because UT would have no reason to oppose
their removal, the partnership restrictions should be treated as
capable of being removed by the Kerr family after the transfers.
We disagree. For a restriction to be considered removable by
the family, the Code specifies that “[t]he transferor or any member
of the transferor’s family, either alone or collectively,” must
have the right to remove the restriction. I.R.C.
§ 2704(b)(2)(B)(ii). The Code provides no exception allowing us to
disregard non-family partners who have stipulated their probable
consent to a removal of the restriction. The probable consent of
UT, a non-family partner, cannot fulfill the requirement that the
family be able to remove the restrictions on its own.
Our holding precludes the restrictions from falling within the
definition of “applicable restrictions” because of § 2704(b)(2)(B).
These partnership agreements contain restrictions both on
liquidation of the entire partnership (§ 10.01) and on the right of
a partner to withdraw from the partnership (§ 9.02) as noted above.
We need not answer the question whether restrictions on a partner’s
right to withdraw should properly be considered a limitation on the
ability to liquidate (under § 2704(b)(2)(A)). Additionally, it
matters not whether the restrictions are more restrictive than
State law (under § 2704(b)(3)(B) and the related regulation).
Because those restrictions do not meet the removability
requirement, they cannot fall within the definition of “applicable
restrictions” regardless.
10
B. The Cross Appeal: Assignee or Partnership Interests?
Taxpayers took a protective cross appeal from the Tax Court’s
determination that the KFLP interests transferred by them to their
GRATs were partnership interests rather than assignee interests.
Taxpayers’ argument was that, if the interests transferred to the
GRATs were assignee interests, then § 2704(b) would not apply since
it affects only partnership interests. We are today affirming the
Tax Court’s ruling that § 2704(b) does not apply to any of the
transfers. Our holding renders moot the question on the cross
appeal whether the interests transferred to the GRATs were only
assignee interests.
III. CONCLUSION
Because the restrictions in the partnership agreements are not
“applicable restrictions” to be disregarded under § 2704(b), the
special valuation rule in I.R.C. § 2704(b) does not apply to the
valuations of the partnership interests transferred. The taxpayers’
marketability discounts on the transferred interests are entirely
appropriate. The judgment of the Tax Court is
AFFIRMED.
11