Gift and estate taxes are paid based on the fair market value of the asset transferred. Family Limited Partnerships (FLPs) and Family Limited Liability Companies (FLLCs) are popular vehicles for estate planning and the mitigation of transfer taxes. In the case of an individual who owns commercial real estate, for example, a transfer tax would be paid on the fair market value of the commercial real estate given to his or her successors.

However, an alternative to transferring the whole property outright would be to contribute the commercial real estate to a Family Limited Partnership and then transfer successive, annual, non-controlling, limited partnership interests to the successors. In this way, the value that is taxed is not the pro rata share of the value of the commercial real estate, but the value of a non-controlling, limited partnership interest in a partnership that owns commercial real estate. This non-controlling interest would be worth much less than its pro rata portion of the fair market value of the underlying property because of lack of control and marketability discounts that would have to be applied in order to induce the hypothetical buyer to buy such a non-controlling, nonmarketable interest.

The derivation of the appropriate discounts is covered in a separate chapter. However, many practitioners rely on the discounts from net asset value of partnerships at which non-controlling interests in such partnerships are traded. In addition, there is reliance on restricted stock and pre-IPO studies as well as control premiums studies of publicly traded equity. Also in the case of an FLP that holds marketable securities, some practitioners look to the discounts from net asset value of publicly traded closed-end mutual funds.

Of key importance in assessing the level of discounts to be applied is not only the inherent risk of the underlying operation, but also the additional risk or decreased return attributable to provisions of the partnership or operating agreement. Provisions in these agreements can restrict transferability, withdrawal, redemption, or distribution to equity holders in such a way that decreases the value of the non-controlling interest being valued.