The application of tiered discounts is a thorny issue for valuation analysts. The issue arises when we perform a valuation, typically of an FLP that owns interest in another LP which owns interest in another LP, and so forth. Most agree that applying discounts for lack of marketability and lack of control depends on circumstances unique to each situation. However, in order to apply discounts at multiple levels (ie., tiers), there must be substance to the legal structure of the entities that goes beyond taking multiple discounts on essentially the same interest.
To successfully defend tiered discounts, the following components should be considered:
(a) Asset class: expected returns.
(b) Financial risk: degree of leverage, earnings history, risks specific to each legal entity.
(c) Governance risk: type of interest, composition of investors, control term of the life of the entity, liquidity.
(d) Distributions: full, partial, or no payout, consistency of payment.
In general, valuation analysts agree that discounts beyond the intitial tier will generally be lower. With respect to the four components, the more consistent the downstream entities are, the lower the downstream discounts should be. As with most cases, better planning results in better fact patterns, which leads to better outcomes.
Astleford v. Commissioner (T.C. Memo 2008-128) is a case where the tax court upheld tiered discounting.
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